Fixed Cost vs Variable Cost

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Difference Between Fixed Cost and Variable Cost

A fixed cost refers to the cost that has to be payable no matter whether there is any production or sale activity in the business or not, like rent payable, salaries payable, and other utilities payable, whereas, Variable cost refers to the cost that varies with the production of goods & services that increase with the increase in production and vice versa like direct material, direct labor, etc.

In finance and economics, one of the critical terms is the cost, which means the cost of production of goods or services. The production cost can now be classified into two major categories based on its nature: fixed cost and variable cost.

Fixed cost, as the name suggests, is fixed in nature during a certain period, and doesn't depend on the activity level or output level. It can be considered a sunk cost. One of the most popular examples is depreciation, which is charged on the fixed assets of a company. Now, the amount of depreciation remains constant (considering the straight-line method) during the years of operation irrespective of production volume.
On the other hand, the variable cost is directly proportional to the output level or production volume. A few of the popular examples are labor charges and material costs. Now, the production level solely derives from the total labor charge or raw material.

Difference Between Fixed Cost and Variable Cost

Fixed Cost vs. Variable Cost Infographics

Let's see the top differences between fixed vs. variable cost.

Example

Interestingly, fixed cost is fixed at a gross level but can come down at a per-unit level with increased production. Let us consider a fixed asset of USD 1000 depreciated over ten years so that the annual depreciation charge will be USD 100. Now, if the company produces ten units, the depreciation charge is USD 10 per unit, while if the company produces 100 units, then depreciation per unit comes down to USD 1 per unit.

While variable cost, on the other hand, is fixed at the per-unit level but increases linearly at a gross level with the increase in production. Let us consider a labor charge of USD 10 per unit, and if the company produces ten units, then the total labor charge is USD 100, while if the company produces 100 units, then the total labor charge is USD 1000.

The Total Cost of Production = Total Fixed Cost + Total Variable Cost

Total cost of production for 10 units = USD 1000 + USD 100 = USD 1100
Total cost of production for 100 units = USD 1000 + USD 1000 = USD 2000

Key Differences

Fixed cost remains constant at the gross level regardless of production volume. At the same time, the variable cost is that cost that changes at a gross level with the level of production.
Fixed cost is time-related as it changes only after a certain period. Whereas the variable cost is volume related varies with the volume of production.
Fixed cost is payable irrespective of whether there is any product or not. At the same time, the variable cost incurs when there is any production.
At the unit level, variable costs remain the same, while fixed cost per unit varies. Fixed cost per unit reduces with the increase in volume production and vice versa.
The fixed cost of production includes fixed production overhead, fixed administration overhead, and fixed selling & distribution overhead. Variable cost, on the other hand, includes raw material cost, labor cost, other direct expenses, variable production overhead, variable selling & distribution overhead.

Fixed Cost vs. Variable Cost Comparative Table

Basis for comparison	Fixed Cost	Variable Cost
Nature	It changes only after a certain period.	It changes with the volume of production.
Gross level	fixed at the gross level;	It increases at a gross level with an increase in production and vice versa.
Unit level	It decreases at a per-unit level with an increase in production and vice versa.	fixed at the per-unit level;
Effect on profitability	The higher level of production reduces the fixed cost per unit, which improves profitability.	The level of production doesn't impact per unit cost and, as such, no impact on profitability.
Risk associated	It is usually capital intensive and, as such, exposed to risk if the company doesn't achieve adequate production level.	It increases with the level of production at a constant rate and measured at the unit level.
Level of control	Fixed cost can't be controlled and is payable.	The company can control the variable cost by controlling the volume of production.
Contribution margin	We don’t consider it during the calculation of contribution margin	We calculate Contribution margin by deducting variable cost per unit from selling price per unit to ascertain the profitability of a product (higher the contribution better the product)
At Zero production	The Fixed cost incurs even if there is no production	There is no variable cost in the case of zero production level
Example	Salary, Depreciation, Insurance, Rent, Tax, etc.	Cost of raw material, Labour wage, Sales commission/incentives, Packing expenses, etc.

Final Thoughts

I hope the article helps you to decipher the two cost categories. As per the above explanations, both cost categories are very different and are essential in financial analysis. The higher volume of production results in better absorption of the fixed cost of production, which improves profitability, while variable cost per unit is instrumental in ascertaining the contribution margin at the product level. So, both the categories are used in unique ways to each other. As such, it is crucial to understand the various facets of the two to apply them successfully in a business scenario.