Fixed Costs

Definition

Fixed costs, in economics, are explained as business expenses which do not depend on the level of goods and services proffered by a business. These costs have a propensity to be time-related. Management studies define fixed costs as expenses which do not change as a function of a business activity, within a required period of time. Moreover, fixed costs also make up one of the components and a strong management tool in calculating the total costs. A higher level of fixed costs can, however, increase the level of operational gearing.

Examples

Some of the examples of fixed cost include rent, insurance, salaries and accountancy costs, forms of depreciation, capital assets, utilities, property tax, or interest expense. Another good example of fixed cost is a lease payment. If, in case, you are leasing a building at $1,000 per month, then you are supposed to pay that amount each month irrespective of the working condition (good or poor) of the business.

Areas of confusion

Fixed costs, although not changing in relation to the production quantity for the germane period, can, however, change over long periods of time. For instance, a business firm might experience unpredictable and unexpected expenses which are not related to production. Similarly, the warehouse costs and alike are fixed only for a certain time period of the lease.

However, in the long run, there are no fixed costs by definition. Investments in equipment, facilities, and the basic organization which can’t be considerably reduced in a short span of time are termed as committed fixed costs. Besides, there are also discretionary fixed costs arising from annual decisions taken by the management to spend on certain fixed cost items. This discretionary cost can be exemplified by expenses like advertising, research & development, and machine maintenance.