## How to Classify Business Costs: Fixed Costs vs. Variable Costs - What Are the Differences?

For entrepreneurs, distinguishing costs is a fundamental component of financial management. Fixed costs and variable costs are two categories that play different roles in a company's cost structure. Understanding the differences between them helps business owners make smarter decisions about pricing, investment, and profitability.

### The Importance of Understanding Costs

Before delving into fixed and variable costs, it is essential to recognize why cost analysis is crucial to business success. Effective cost management is a guiding factor that helps businesses:

- Set appropriate product or service prices to cover expenses and generate profit
- Plan investments and resource allocation wisely
- Evaluate the (Break-even Point) to determine suitable sales targets
- Forecast the impact of market changes on financial stability

## Fixed Costs (Fixed Cost): Key Components of Business Expenses

### Definitions and Characteristics

Fixed costs are expenses that do not change with the level of production or sales. Whether the business grows or stalls, these costs remain constant. This is why fixed costs are often called "Overhead Costs" or "Life Costs."

### Examples of Fixed Costs in Business

**Rent**: Housing for employees, office space, or hotel rooms must be paid monthly regardless of occupancy or customer volume. These rent costs stay the same.

**Salaries of permanent staff**: Full-time employees or long-term contract workers receive fixed salaries regardless of workload.

**Insurance**: Asset insurance, liability insurance, or other business insurances must be paid regularly.

**Depreciation of assets**: When purchasing machinery, buildings, or trucks, depreciation costs are calculated periodically based on useful life.

**Loan interest**: If the business borrows funds to start or expand, interest payments are made monthly regardless of profit or loss.

**Basic utilities (Utilities)**: Although some electricity, water, and internet costs are variable, the (contract fee) is considered a fixed cost.

### The Significance of Using Fixed Costs in Financial Management

Understanding fixed costs helps businesses to:
- **Plan long-term finances**: Since fixed costs are stable, expenses can be forecasted accurately.
- **Determine minimum costs**: The business must sell enough to cover fixed costs at least.
- **Assess risk**: High fixed costs mean the business needs consistent revenue; otherwise, it risks financial strain.

## Variable Costs (Variable Cost): Costs that fluctuate with circumstances

### Definitions and Main Characteristics

Variable costs are expenses that increase or decrease directly with the level of production or sales. If production doubles, variable costs roughly double. Conversely, if sales decrease, variable costs decrease accordingly.

### Types of Variable Costs

**Raw materials and components**: If a hotel decides to prepare more meals, the cost of ingredients increases. Similarly, fewer customers lead to lower raw material costs.

**Direct labor wages (**: If the business needs to increase production, additional hourly or piece-rate labor may be hired. These costs rise with the amount of work.

**Packaging costs**: Each product unit sold requires packaging, such as boxes, labels, or plastic straws.

**Transportation and delivery**: More products produced and delivered mean higher transportation costs.

**Variable utilities )Utilities(**: Increased electricity usage for production results in higher electricity bills.

**Sales commissions**: Agents or distributors paid based on sales volume or other performance-based formulas.

) Application of Variable Costs in Management

Businesses can use variable cost data to:
- **Improve production efficiency**: Reduce raw material costs by sourcing cheaper suppliers.
- **Adjust production levels**: Increase or decrease production according to market demand.
- **Evaluate cost per unit**: Understand the cost of each product.

## Comparing Fixed and Variable Costs

| Feature | Fixed Costs | Variable Costs |
|--------|--------------|----------------|
| **Change with volume** | No change as production volume varies | Increase or decrease with production volume |
| **Examples** | Rent, salaries, insurance | Raw materials, direct wages |
| **Forecasting** | Can be predicted accurately | Depends on sales volume |
| **Flexibility** | Less flexible | Highly flexible |
| **Impact on break-even point** | Significantly affects break-even point | Affects per-unit cost |

## Combining Costs: How to Calculate Total Cost

### Fixed and Variable Cost Formula###

**Total Cost = Fixed Costs + (Variable Cost per Unit × Number of Units Produced)**

Example: A hotel has fixed costs of 100,000 THB per month (rent, wages, insurance) and a variable cost per room of 200 THB (food, linens, products).

- If there are 300 rooms occupied: Total cost = 100,000 + (200 × 300) = 160,000 THB
- If there are 500 rooms occupied: Total cost = 100,000 + (200 × 500) = 200,000 THB

In this example, as occupancy increases, variable costs increase, but fixed costs remain the same.

### Applying Cost Formulas in Decision-Making

**Pricing**: The hotel must set room prices higher than the total cost per room to generate profit.

**Production planning**: Calculating total costs helps management decide how much to sell to cover costs and achieve target profit.

**Investment evaluation**: To increase revenue, decide between investing in new machinery (increase fixed costs) or hiring more staff (increase variable costs) by comparing total costs of each option.

## Analyzing the Importance of Cost Data in Business Decisions

### Using Cost Data to Control Cash Flow

- **Identify excessive costs**: Is rent too high? Maybe the business should move to a cheaper location.
- **Find savings**: Seek suppliers offering lower raw material prices.
- **Improve efficiency**: Reduce waste, cut labor costs, and lower utility expenses.

### Setting Profit Goals

Once fixed and variable costs are known, businesses can:
- Calculate (Break-even): the sales volume needed to cover all costs
- Set sales targets to achieve desired profits
- Assess risks when market conditions change

## Summary

Fixed and variable costs are core components of business financial management. Clearly distinguishing and understanding both helps managers and owners to:

- **Price products competitively**: Cover all costs and generate profit
- **Plan growth**: Understand investment needs and profit potential
- **Manage risks**: Recognize cost stability and flexibility
- **Choose financial strategies**: Whether to increase fixed costs to reduce variable costs, or vice versa

A deep understanding of fixed and variable costs, along with correct application of cost formulas, provides a solid foundation for effective business management and long-term sustainability.