What are fixed fees and why are they important?

What are fixed fees and why are they important?

What are fixed fees and why are they important?

Running a business involves countless ongoing tasks, but the most critical one is managing the financial situation of the business. In addition to recording income and repaying debts, you must also keep track of various expenses.

Understand your company’s Fixed costs and Variable expenses can help you stay healthy cash flow, Budget more efficiently, and increase your profits. Read on for more information about what fixed fees are, why they are important, and how to control them.

What is a fixed fee?

Fixed expenses refer to business costs that remain the same every month, regardless of your business output or income. Sometimes called overhead, Fixed cost It is usually the lowest cost your business needs to pay to keep your operations running normally.

Examples of fixed fees include:

  • Rent or mortgage payment
  • property tax
  • Interest payment
  • Employee salary
  • Loan payment
  • insurance

Due to the nature of the industry or work, some companies have high fixed costs. manufacturingFor example, retail and automobile companies often have to pay high rents or mortgages to pay insurance policies and maintain stores, factories, or warehouses.

Other businesses, such as online stores or social media mechanism, If they don’t have to pay for the physical store or office, the fixed fee may be lower. However, companies with lower fixed expenses may end up spending more money on variable expenses.

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Fixed costs and variable costs

As the name suggests, variable expenses are business costs that vary from month to month. Depending on your specific business, spending more on variable expenses can improve your product quality and lead to higher sales or revenue; however, allocating more money to variable expenses can also limit your cash flow.

Example Variable costs include:

  • stock
  • Public utilities
  • Supplies
  • raw material
  • labor
  • Shipping
  • Recruitment needs
  • Marketing And advertising
  • Office maintenance
  • Employee’s hourly wage

Companies with high variable costs include restaurants, E-commerce website, And niche businesses such as pet custody or consulting. Generally speaking, the higher the sales demand of this type of business, the greater the variable cost.Restaurant or Food truck Is a typical example. If you have more customers, you will inevitably need to spend more on food and labor to serve these people.

Why is it important to understand fixed and variable costs?

Knowing your business expenses is the first step to operating a profitable business.If you don’t know how much cash you spend every month, it’s difficult to price your product or service at the right price Cost structure, Maintain Positive cash flow, Pay off your loan, or increase your income.

On the other hand, total expenses give you a clear picture of the cost of running your business—and what you can save. Knowing your fixed and variable costs can help you:

  • Identify cash flow gaps
  • Save reserves to plan Slow period
  • Identify where you are overspending and find out how to reduce it
  • Link costs to their impact on profits
  • Budget for the next few quarters
  • Create Annual budget

How to calculate the average fixed cost

Calculating the average fixed cost of a business can give you an idea How much does your business spend per unit Fixed costs, which can help you make more informed decisions around administrative expenses and production costs. But remember: this number does not account for variable costs, so it is not the only number you should look at.

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This is the formula for average fixed cost:

Average fixed cost = total fixed cost / number of units produced

To add up your fixed expenses, check your most recent annual income statement, and then add up all expenses that occur regularly and unchanged every month.

Suppose you run an online store that sells sunglasses. Your total fixed cost that year was $60,000, and you produced 7,000 pairs of sunglasses. Using this formula, your average fixed cost per pair of sunglasses is $8.50. However, if you can produce more products (such as 10,000 pairs of sunglasses) with the same fixed cost, you can reduce the average fixed cost per item to $6.

How to calculate the break-even point of an enterprise

It is also helpful to calculate the break-even point of a business in units of units; this number is the number of units you need to produce to cover all fixed and variable expenses.Finding the break-even point can help you avoid loss of profit by setting Realistic sales target Weekly, monthly, quarterly and yearly.

The break-even formula is:

Breakeven point = fixed expense/(unit price x unit variable cost)

you can use it Average variable cost formula Determine the unit variable cost. The formula is:

Average variable cost = variable cost / total unit of production

Let’s use the same example of running an online sunglasses store. In addition to the fixed fee of $60,000, suppose your business sells each pair of sunglasses for $14, and the material, labor, packaging, and transportation costs to make each pair of sunglasses are $9 (unit variable cost). Using this formula, your business must manufacture and sell 476 pairs of sunglasses each year to achieve a balance of payments. However, to be profitable, you have to manufacture and sell much more than that.

How to reduce fixed expenses

Reduce corporate fixed expenses It can be tricky, but even a small adjustment can greatly release your cash flow. If you want to reduce fixed costs, you can use the following methods:

  • Negotiate with the landlord to reduce rent
  • Sublet part of the building to another company to save rent
  • Refinance Commercial loans Get a lower payment
  • Reduce the number of salaried employees
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How to reduce variable costs

Reducing the variable costs of a business is another effective way to increase cash flow, but it also requires a lot of strategies—and some trial and error. You must ensure that you will not cut costs that directly affect product quality. In order to strike the right balance, first divide your variable expenses into three categories:

  • Expenses that directly affect business income, such as inventory
  • Expenses that indirectly affect revenue, such as customer management software
  • Expenses that do not affect income at all, such as office kitchen snacks
  • You may not want to reduce the cost of the first category, but you can reduce the cost of the second category by a quarter, and the cost of the third category by half or more.Here are some strategies Reduce variable costs:

    • Switch to a free commercial software provider
    • Negotiate discounts for bulk orders with your supplier
    • Look for financial leaks in your business
    • Outsourcing Administrative tasks or small jobs

    Know your expenses

    Your expenses are the core of corporate finance.Knowing how much you spend on fixed and variable costs each month is critical to maintaining operations and profitable.Whatever you want to create Tighten the budget, Establish a cash reserve or increase cash flow, and a more detailed understanding of fixed and variable expenses will help.

    Fundbox and its affiliates do not provide tax, legal or accounting advice. This material is for reference only and is not intended to be provided and should not be used as a basis for tax, legal or accounting advice. Before conducting any transaction, you should consult your tax, legal and accounting advisors.

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