What Is the Difference Between the Different Cost Types?
Fixed costs, total fixed costs, and variable costs all sound similar, but there are significant differences between the three. The main difference is that fixed costs do not account for the number of goods or services a company produces while variable costs and total fixed costs depend primarily on that number.
Key Takeaways:
- Fixed costs do not account for the number of goods or services a company produces
- Variable costs and total costs depend on the number of goods or services a company produces.
- Companies must consider both types of costs to ensure they are fiscally solvent and thriving over the long term.
Understanding the Different Cost Types
As the name suggests, fixed costs do not change as a company produces more or less products or provides more or fewer services. For example, rent paid for a building will be the same regardless of the number of widgets produced within that building. In contrast, variable costs do change depending on production volume. For example, the cost of materials that go into producing the widgets will rise as the number of widgets produced increases.
Fixed Costs
A fixed cost is an expense that a company is obligated to pay, and it is usually time-related. A prime example of a fixed cost would be the rent a company pays for office space and/or manufacturing facilities on a monthly basis. This is typically a contractually agreed-upon term that does not fluctuate unless both landlords and tenants agree to re-negotiate a lease agreement.
In the case of some rental properties, there may be pre-determined incremental annual rent increases where the lease stipulates rent hikes of certain percentages from one year to the next. However, these increases are transparent and baked into the cost equation. Consequently, accountants can calculate their companies' overall budgets with the lead time necessary to ensure a business's bottom line is protected. This is typically how rent-controlled properties operate.
Variable Costs
Variable costs are functions of a company's production volume. For example, widget company ZYX may have to spend $10 to manufacture one unit of product. Therefore, if the company receives and inordinately large purchase order during a given month, its monthly expenditures rise accordingly.
Another example is a retailer that doubles its typical order to prepare for a holiday rush. This increases company ZYX's expenses to fulfill the order. Larger purchase orders may also result in increased overtime pay for employees.
Conversely, purchase orders may decline during off-seasons and slower economic times, ultimately pushing down labor and manufacturing costs accordingly. In addition, the costs of commodities and other raw materials for manufacturing may rise and fall, which can also affect a company's variable expenses.
Total Costs
Total costs are composed of both total fixed costs and total variable costs. Total fixed costs are the sum of all consistent, non-variable expenses a company must pay. For example, suppose a company leases office space for $10,000 per month, rents machinery for $5,000 per month, and has a $1,000 monthly utility bill. In this case, the company's total fixed costs would be $16,000.
In terms of variable costs, if a company produces 2,000 widgets at $10 per unit, and it must pay employees $5,000 in overtime to keep up with the demand, the total variable costs would be $25,000 ($20,000 in products plus $5,000 in labor costs).
Consequently, the total costs, combining $16,000 fixed costs with $25,000 variable costs, would come to $41,000. Total costs are an essential value a company must track to ensure the business remains fiscally solvent and thrives over the long term.
FAQs
Fixed costs, total fixed costs, and variable costs all sound similar, but there are significant differences between the three. The main difference is that fixed costs do not account for the number of goods or services a company produces while variable costs and total fixed costs depend primarily on that number.
What is the difference between total fixed cost and total variable cost? ›
Fixed costs are expenses that remain the same no matter how much a company produces, such as rent, property tax, insurance, and depreciation. Variable costs are any expenses that change based on how much a company produces and sells, such as labor, utility expenses, commissions, and raw materials.
What is the difference between TFC and TVC? ›
Total fixed cost (TFC) is that cost which does not change with a change in the level of output. Total variable cost (TVC) is that cost which changes as the level of output changes. Total cost (TC) is the sum of total fixed cost and total variable fixed cost.
What is the difference between a fixed cost and a variable cost? ›
Fixed cost includes expenses that remain constant for a period of time irrespective of the level of outputs, like rent, salaries, and loan payments, while variable costs are expenses that change directly and proportionally to the changes in business activity level or volume, like direct labor, taxes, and operational ...
What is a fixed cost example? ›
Fixed costs tend to be costs that are based on time rather than the quantity produced or sold by your business. Examples of fixed costs are rent and lease costs, salaries, utility bills, insurance, and loan repayments. Some kinds of taxes, like business licenses, are also fixed costs.
What is total fixed cost and fixed cost? ›
Total fixed cost is the total amount of money a business must pay to keep their operations running regardless of how many products they make or sell. Total fixed cost does not change regardless of production or lack of production. Fixed costs are those that still exist even when production is at zero.
What is an example of a total cost? ›
Essentially, total cost is the entire amount of money that must be spent on something to either produce, maintain, or own it. Take the example of building a car. There are many different costs that go into the process of building a car, and all of these costs together form the total cost of production.
How to calculate TVC and TFC? ›
It has two components Total Variable Cost (TVC) and Total Fixed Cost (TFC). TC = TVC + TFC. When output level is 0, the TVC is 0 but not TFC because we have to pay the rent, interest on loans etc. So here, TC = TFC.
What is the total variable cost? ›
Variable costs are the sum of all labor and materials required to produce a unit of your product. Your total variable cost is equal to the variable cost per unit, multiplied by the number of units produced. Your average variable cost is equal to your total variable cost, divided by the number of units produced.
What is the formula for TFC and TVC? ›
Total Fixed Cost TFC:- The total amount of money spends on fixed factors of production is called fixed cost.It can be obtained by subtracting total variable cost from total costTFC = TC - TVCTotal Variable Cost TVC:- The total amount of money spends on variable factors of production is called total variable cost.
Examples of variable costs are sales commissions, direct labor costs, cost of raw materials used in production, and utility costs. Variable costs are usually viewed as short-term costs as they can be adjusted quickly.
What is the difference between a fixed cost and a variable cost quizlet? ›
Fixed costs do not change when the business changes its level of output e.g. rent, rates and salaries. Variable costs change with the business's level of output e.g. fuel costs, wages, raw materials and components.
What is an example of a variable expense? ›
Fixed expenses are costs that largely remain constant, such as your monthly rent or mortgage. Variable expenses, on the other hand, are costs that may vary or be unpredictable, such as a car repair or a medical bill.
What is meant by total costs? ›
total cost, in economics, the sum of all costs incurred by a firm in producing a certain level of output.
What is the total fixed cost? ›
Total Fixed Cost (TFC) This refers to the costs incurred by a firm in order to acquire the fixed factors for production like cost of machinery, buildings, depreciation, etc. In short run, fixed factors cannot vary and accordingly the fixed cost remains the same through all output levels.
What is fixed cost? ›
A fixed cost is an expense that does not change when sales or production volumes increase or decrease. Fixed costs are the expenses a business incurs that do not change with the amount of goods produced or services provided. These costs are not directly associated with manufacturing a product or delivering a service.
What is the relationship between TC TVC and TFC? ›
Since the TFC curve is horizontal, the difference between the TC and TVC curve is the same at each level of output and equals TFC. This is explained as follows: TC – TVC = TFC. The TFC curve is parallel to the horizontal axis while the TVC curve is inverted-S shaped.
What is fixed cost and variable cost with an example? ›
Fixed costs are expenses that remain the same regardless of the level of production, while variable costs change based on the production output. Rent, advertising, and administrative costs are examples of fixed costs, while examples of variable costs include raw materials, sales commissions, and packaging.
How to find total fixed cost total variable cost and total cost? ›
A company's total costs are equal to the sum of its fixed costs (FC) and variable costs (VC), so the amount can be calculated by subtracting total variable costs from total costs.
