Fixed costs are expenses that remain constant regardless of changes in business volume or output — such as rent, salaries of permanent staff, and depreciation — while variable costs change proportionally with business activity, such as raw materials, direct labour on a per-unit basis, and sales commissions. The classification of costs as fixed or variable is fundamental to understanding how profitability changes with revenue, calculating contribution margins, setting pricing strategies, and modelling financial scenarios.
Why This Matters
The fixed/variable cost distinction is the foundation of margin analysis and financial scenario modelling. It determines how the business’s profit responds to changes in revenue: in a business with predominantly fixed costs, incremental revenue above the break-even point drops almost entirely to profit; in a business with predominantly variable costs, the margin on incremental revenue is constrained by the variable cost proportion. This distinction directly informs pricing decisions, capacity planning, and the assessment of operational risk.
Where This Fits
This term sits within the Performance Analysis area of Performance & Control.
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