Recently, I’ve been thinking about a question: many people don’t really understand what they are actually spending money on when doing business. Some costs must be paid regardless of whether your business is good or not, while others increase the more you produce. The difference between these two types of costs actually relates to whether you can survive and also determines your pricing strategy and profit margins.

First, let’s talk about those costs that must be paid no matter what, which are called fixed costs. For example, the rent for your office or factory, which you have to pay every month, even if you don’t sell a single product this month. The fixed wages for employees are also included—you need to keep paying them. Insurance fees, loan interest, equipment depreciation—these all fall under fixed costs. The characteristic of this type of cost is that it is completely unaffected by your production volume or sales; producing more or less doesn’t change it.

This is why understanding fixed costs is so important. If you don’t know how much your fixed costs are each month, you simply can’t calculate how much you need to sell to avoid losing money. Many small businesses fail because the founders don’t realize how large those hidden fixed costs are. You need to allocate these fixed costs to each product, then add variable costs, and finally include the profit you want, so you can set a reasonable price.

Next are variable costs, which are more straightforward. Raw material expenses, packaging costs, logistics fees, direct employee wages—these all change with your production volume or sales. The more you produce, the higher these costs; the less you produce, the lower they are. Variable costs give you some flexibility because, in theory, you can reduce costs by decreasing production.

The key is to consider both parts together. Fixed costs plus variable costs make up your true costs. Some companies try to lower variable costs by increasing fixed costs, such as buying automated machinery to replace manual labor. The advantage of this is that when production increases, the unit cost decreases. But the risk is that if sales suddenly drop, those fixed investments become a burden.

In practical operations, this analysis is especially important. If you want to evaluate whether an investment project is worthwhile, you must calculate how much fixed costs will increase and how much variable costs can be saved. If you want to respond to market changes, you also need to understand what proportion of your costs are fixed, so you can judge how flexible you are. Some industries have high fixed costs, like manufacturing; others have variable costs as the main component, like e-commerce.

Overall, the combination of fixed costs and variable costs determines your business model. Understanding these two types of costs allows you to price more accurately, plan capacity more intelligently, and make investment decisions with more confidence. This is not just financial knowledge; it’s business wisdom.