Fixed costs are costs that are not related to the level of activity and which do not increase or decrease with the change in the level of activity.
For instance, if you make 1 unit or 10,000 units of a product in a rented factory, you’ll have to pay the same amount of rent. Therefore, rent is a fixed cost.
Examples of fixed costs
Here are some examples of fixed costs:
- Factory rent.
- Insurance expense.
- Property taxes.
- Depreciation of non-current assets (straight line method or reduction balance method).
- Salaries of Factory Manager and Supervisors.
In total terms, fixed cost will remain constant regardless of the level of activity as shown in the following graph.
As fixed costs in total remain constant in a period, production of more units means each unit will get a smaller share of fixed costs. Therefore, fixed costs per unit tend to decrease with the increase in the level of activity as shown in the following graph.
Purpose of analysing fixed costs
Managers often analyse total costs according to their behavior. Some of the benefits of analysing fixed costs are given below.
- The concept of fixed costs helps the business to identify breakeven point, i.e., sales required to make no profit no loss.
- It helps in pricing decisions as a business looks to set an optimum price for its products that will cover its total costs (fixed and variable) and generate some profit.
- Managers can periodically review the fixed costs to identify any room for cost-cutting.
- Information about fixed costs helps the managers in making budgets and forecasts.