Definition of Fixed Costs Example
Fixed cost is the expense of the company which doesn’t change with the change in the volume of production within the relevant range. The company has to pay it, independent of any activity in the business over that period. So it is the periodic cost that remains unchanged mostly. There are several examples of fixed costs. The below mentioned different fixed costs example give an understanding of the different fixed costs present in any business and its calculation.
How Fixed Costs Example works?
The following list will identify and describe different costs in order to help you clarify what a fixed cost is.
Example – 1
Following are some of the different types of Fixed Costs that the business enterprise has to incur:
- Lease on Office Space: Unless & until the business operates in the same building, the rent doesn’t change. It will be a riodical cost.
- Utility Bills: Utility bills like electricity might vary per the season but will not be affected by the business level.
- Website Hosting Costs: On registering the business website domain, monthly charges have to be paid for the same, which remains static irrespective of the level of business.
- Property Tax: The property tax paid in respect of the office premises is as per the value of the property and not based on the scale of business.
- Interest Expenses: This is the cost of funds funded by a lender to a business. The amount of interest will be based on the outstanding loan amount and not on the production or business level.
- Insurance: This is a periodic cost that is to be paid annually as per the initial arrangement made but is not at all based on the business level.
- Amortization / Depreciation: These are gradually charging the expense of intangible/tangible assets over their useful life. Its value depends on the useful life of an asset.
- Salaries: This is compensation made to employees as per the initial offer made to them, and it is irrespective of their hours worked.
Example – 2
Calculation of Fixed Cost
Mr. X started the bakery shop one year ago. During the last year, his business was working very nicely. But last month two new competitors also started the same line of business in the same locality which leads to the decrease in the sale of bakery shop of Mr. X, and it is expected that in the coming year sales would decrease further, and he has to incur the losses if he continues the operations. Seeing this, Mr. X is worried whether it would be feasible to continue the business further or not. During the month of January, it incurred some of the costs which are given below. Mr. X now wants to know how much he spends against the fixed cost so that he can analyze whether to continue business or not.
- Paid the rent for the whole year, amounting to $12,000.
- Paid the Electricity expense to the owner of the shop for a whole year in advance, amounting to $3,600.
- Paid the cost of raw material required for a bakery in the month of January, amounting to $2,000.
- Cost of labour on the basis of the number of hours for preparing the finished goods $600.
- Insurance Expenses for the whole year amounting to $3,600 paid in the month of January.
Calculate the fixed cost for the month of January.
Fixed Cost = Monthly Rent + Monthly Electricity Expense + Insurance Expense
Fixed Cost = $1,000 + $300 + $300
Fixed Cost = $1,900
These are the fixed cost that should not be considered while deciding whether the business operations should be continued or not because these are the cost that the owner has already paid.
- Rent is paid in advance for the whole year, and it is fixed in nature. So it will be part of the fixed cost. In the present case, rent for the whole year is $12,000. So, for one month rent will be $1,000 ($12,000 / 12).
- Electricity is paid in advance for the whole year to the owner of the shop, and it is fixed in nature. So it will be part of a fixed cost. In the present case, Electricity expense for the whole year is $3,600. So, for one month, rent will be $300 ($3,600 / 12).
- Raw material changes with the production level, so this will not be considered a fixed cost and will be part of variable cost.
- Cost of labour changes with the number of hours worked for, so this will not be considered as fixed cost and will be part of variable cost.
- Insurance expense is paid in advance for the whole year, and it is fixed in nature. So it will be part of a fixed cost. In the present case, the Insurance expense for the whole year is $3,600. So, for one-month Insurance expense will be $300 ($3,600 / 12).
Example – 3
The Company’s short-run cost function is given by the C = 210 + 51 Q, where C is the company’s total cost and Q is the quantity of output. Next, calculate the fixed cost of the company?
As the fixed cost is part of the cost of the production, which is not dependent on Quantity of Output, i.e., it is independent of the Q, from the short-run cost function given by the C = 210 + 51 Q, it can be seen that 210 is independent of the Q. So, in the present case fixed cost is 210 (unit of money).
Also, using the formula for calculation of costs is given by TC = FC + VC (Q), where FC is the fixed costs, it can be concluded that in equation fixed cost is 210.
Fixed cost is the committed cost that has to be incurred even at the zero levels of production or business level. This concludes that if a business has a higher amount of fixed cost, its profit margin will get squeezed when sales fall. The higher the fixed, the higher will be its break-even quantity, which means it has to sell many products to achieve a breakeven point that will be no profit, no loss situation. Therefore, a company with a relatively high amount of variable cost can estimate its per-unit profit margin more accurately. At the same time, a business model with a higher amount of fixed cost discourages the new entrant.
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