Variable vs Fixed Expenses: What's the Difference?
At first glace, expenses seem like a simple topic. You pay money to get a product or a service, while making sure not to go over budget. While this core concept remains true, not all expenses are the same and expenses start to multiply as a business grows. In this guide, we will define and differentiate between types of expenses: Variable and Fixed. These will factor in when you determine product pricing and your budget.
Fixed Expenses are any expense that largely doesn’t change based on the amount you produce or consume of it. Think of watching Netflix. When we have down time, many of us like to relax by watching television. Take note that the monthly subscription price remains the same regardless of whether you watch thirty minutes or five hours. That is because it is a fixed expense. The same is true for Union Kitchen’s fixed expenses. At Union Kitchen, your fixed expenses will include, among others: paying for equipment, facility costs, and QuickBooks.
Variable expenses, meanwhile, are the opposite kind of expense. Unlike fixed expenses, variable expenses fluctuate based on the amount you produce or consume. Think of a bill at a restaurant. The more food your order, the more expensive the final bill will become. When you're looking at your variable expenses for launching a packaged product, your focus will inevitably turn to your costs of goods sold (COGS). We discussed COGS at length in a previous guide that we recommend reading as the two concepts are closely aligned.
Let’s say, for example, your business is selling cakes, and business has been going well. You may decide that you want to scale up production. Congratulations! Just keep in mind, your variable expenses will go up as you do this. In cases of food products, the cost of the goods includes: ingredients, labor, and packaging costs. Since you're going to be making more cakes, you’ll need to purchase more eggs, flour, milk, etc. You’ll also likely need to hire more workers, as the labor demand is going to increase. Finally, you’ll also need to purchase more packaging to hold your products.
Anytime you plan making changes that impact your COGS, be sure that your variable expenses won’t go up too dramatically and outpace available cash flow. Otherwise, you could quickly find yourself going over budget.
Rates and You
Now that you have a better understanding of fixed and variable expenses, you may be wondering which to focus on first and which to spend more time on. While there is no exact right answer, we recommend first tabulating your fixed expenses since these will largely remain the same month over month. Once you determine your fixed expenses, you can focus on variable expenses and lowering your COGs.