What are fixed costs? Types, examples and how to calculate in 2025

As a business owner, effectively managing your costs is crucial for profitability, and understanding fixed costs is a key part of that process.

In fact, small business owners report a lack of financial literacy, causing them to lose an average of $118,121 in profit.

Understanding fixed costs is a crucial aspect of cost accounting, allowing business owners to analyze these consistent expenses and their impact on profitability. 

Identifying and calculating your fixed costs lets you track the baseline expenses your business has to cover, regardless of production or sales volume. This knowledge is essential for setting accurate pricing, planning for the future, and, ultimately, ensuring your business's financial stability.

How do fixed costs work?

4 types of costs: fixed, variable, direct, and indirect costs

How to find and calculate fixed costs

Total fixed cost formula

Are fixed costs included in operational costs?

Examples of fixed costs

Calculate the average fixed cost

What is a breakeven point, and how is it calculated?

Ways to reduce fixed costs

Streamline your accounting and save time

How do fixed costs work?

Fixed costs (or fixed expenses) are constant, regardless of changes in sales or production levels. These are the baseline costs your business incurs simply to operate, whether you produce one unit or one thousand.

Understanding fixed costs helps you:

• Achieve financial stability. Know these costs to ensure you have sufficient revenue to cover them, providing a stable financial foundation.
• Set accurate pricing. Ensure your prices cover both fixed and variable costs, leading to profitability.
• Plan for the future. Predict expenses and budget effectively, even during slow periods.
• Identify areas for cost reduction. Analyze fixed costs to find potential savings.
• Leverage economies of scale. Maximize output with existing fixed assets to increase profit margins. For example, a business that increases production with the same $20,000 piece of equipment generates higher profits as the fixed cost of that equipment is spread across more goods.

Fixed costs vs. variable costs

While fixed costs are predictable, variable costs, such as labor or materials, change as your sales and production levels fluctuate. They're relevant to fixed costs because both contribute to the overall cost structure of a business, as the total cost of a product or service is the sum of both types of costs.

Analyzing how these costs interact can help you determine your breakeven point and profitability. As production increases, fixed costs will generally stay the same, while most variable costs will increase.

4 types of costs: fixed, variable, direct, and indirect costs

In addition to fixed and variable costs, costs may be either direct or indirect. 

• Direct costs. These business expenses can be traced directly to the product or service. Commonly, raw materials and labor are direct costs.
• Indirect costs. Also known as overhead, these costs aren’t directly linked to a particular product or service. Instead, they support overall business operations.

These four terms are related and explain why a business incurs a particular cost. Let's use "Prestige Clothing" as an example to illustrate these cost types.

How to find and calculate fixed costs

You can use your income statement to find and calculate the total fixed expenses your business incurs:

Locate the expense section 

Begin by opening your income statement (also known as a profit and loss statement) for a specific period, such as a month, quarter, or year. Scroll down to the "Expenses" section. 

This section details all the costs incurred by your business during that period. It includes costs like interest, utilities, rent, wages, costs of goods sold (COGS), and more.

Identify fixed expense line items 

Within the expense section, look for line items that represent costs that remain consistent regardless of your sales or production volume, like rent or insurance.

You may want to note these expenses on the side for reference later.

Distinguish from variable expenses 

Differentiate fixed expenses from variable expenses like raw materials, sales commissions, and hourly wages. These are all costs that change depending on your production and sales.

Note these expenses on the side for later use, such as calculating total costs. 

Find the variable cost per unit 

Divide the total variable costs incurred by the number of units produced during that period. For example, this could mean dividing the cost of materials by the units your company produced with those materials.

Variable cost per unit formula

Variable cost per unit = total variable cost / total units produced

Calculate total fixed costs 

Once you've identified all the fixed expense line items, add them together to calculate your total fixed costs for the period. This total represents the baseline expenses your business must cover, regardless of its level of activity.

Calculate total costs 

Total costs are the sum of all fixed and variable costs incurred. Your income statement may calculate this for you, so be sure to read it carefully.

Total cost formula

Total cost = fixed cost + variable costs

Total fixed cost formula 

Total fixed cost = total cost - total variable cost

Or

Total fixed cost = sum of all fixed costs

Are fixed costs included in operational costs?

Yes, there are some fixed costs that are also operational expenses. If you look at operational costs as a whole, they're usually variable because operational expenses can vary.

Variable operational costs include:

• Income tax
• Raw materials
• Contract labor
• Repairs

Fixed operational costs include:

• Rent
• Utilities
• Salaried labor
• Property tax
• Insurance
• Advertising

Examples of fixed costs

Fixed costs can vary from business to business, but here are some common examples:

Rent

The monthly amount you owe your landlord doesn't fluctuate based on your sales or production levels. You'll always pay the amount you agreed upon in your lease, so rent is a fixed cost.

Management salaries

Salaries are an indirect fixed expense. When you hire a new employee, their salary is stated in their offer letter and only changes if they're awarded a raise. Salary costs are constant and don't change based on sales or production.

Insurance premiums

Insurance is a fixed cost. It’s based on the premiums listed in an insurance policy. If you use insurance, you may have to pay for covered services to meet a deductible, but the premiums won't change unless you get a new policy.

Loan interest payments

Interest expenses from a loan are fixed costs. They’re based on your loan’s interest rate and the principal amount you owe. Loan payments typically include the playing off the principal balance, plus interest, and they don't change unless you re-negotiate with your lender or refinance the loan.

Property taxes

Property taxes stay the same, based on the value of the property taxed and the tax rate. Certain areas reassess property more often than others, but your taxes will stay the same between each re-assessment.

Depreciation

Depreciation is when something loses value over time. It's a fixed cost because this is an expected loss of value, not impacted by sales or production. For example, if you purchase a forklift for your warehouse, after three years of use, that forklift will be less valuable.

Examples of variable costs

Since variable expenses often relate to individual transactions or production units, you'll likely see more of them in an income statement than fixed costs. 

Since variable costs directly fluctuate with business activity and can significantly impact profit margins, managing them is crucial for profitability.

Here are three common examples:

• Utility costs. Utilities like water or electricity will fluctuate based on production or usage levels. For instance, your electricity bill increases based on extreme weather conditions and the size of the space that you heat and cool.
• Hourly wages. If you increase your production schedule, these costs increase. Businesses often use hourly wages instead of salaries when staffing needs are unpredictable or directly tied to fluctuating production levels.
• Raw materials. The cost of materials used to create a product will increase as more products are made.

Calculate the average fixed cost

Average fixed costs divide a business’s total fixed costs by the number of units produced. The ratio produces a fixed expense per unit. The formula follows:

Total fixed costs/number of units produced = average fixed cost

For example, if Prestige Clothing’s total fixed expenses were $300,000 one year and they produced 15,000 shirts, the average fixed cost per shirt is $20. 

Businesses often use average fixed costs to figure out how efficient their production system is. However, average fixed costs can be misleading because they decrease as production increases, even if total fixed costs remain the same. 

This can lead to incorrect pricing and doesn't consider that marginal cost—or the cost to produce one more unit impacts profitability after fixed costs are covered.

In our same example, if Prestige can produce 20,000 shirts for the same $300,000, they can reduce their average fixed cost to $15.

Additionally, once total fixed costs are covered, each additional unit produced after that point costs less and generates more profit.

So, if by December 27, Prestige Clothing produced and sold 15,000 shirts, each priced with a $20 fixed cost, this would cover the $300,000 total fixed expenses for the year. 

That means an order for 300 shirts delivered by December 31 would only have marginal costs.

What is a breakeven point, and how is it calculated?

Several useful formulas use fixed and variable expenses, including the breakeven-point-in-units formula. This breakeven-point-in-units formula calculates the number of units you must sell to cover all costs. Each unit sold above the break-even point generates profit.

Breakeven point formula

The breakeven-point-in-units formula divides the business’s fixed costs by the sales price per unit subtracted from the variable costs per unit. The formula follows:

Fixed costs / (sales price per unit – variable costs per unit) = breakeven point in units

Let’s say Prestige sells a jacket for $100. The variable costs per jacket are $60, and the business incurs $200,000 in fixed costs. Using the breakeven-point-in-units formula, Prestige finds their breakeven point in units is 5,000 jackets. If Prestige sells 5,100 jackets, they make a profit on 100 jackets.

If you want to find your ideal breakeven point in units, you might adjust the sales price, variable costs, and fixed costs. If you know the details of the costs you incur, you can perform an analysis to lower costs, increase sales, and boost profits.

Ways to reduce fixed costs

Lower fixed costs can improve cash flow and help you maximize profits. Some common ways you can reduce your fixed expenses include:

• Negotiate lower wholesale prices
• Improve efficiency with automation
• Conduct accurate inventory management
• Boost employee retention
• Lower operational costs with co-working or remote options

Streamline your accounting and save time

Understanding and managing your fixed costs is crucial for your business's financial health. Accurately tracking these expenses, calculating average fixed costs, and determining your break-even point are key to making informed decisions that drive profitability.

By leveraging QuickBooks accounting software, you gain the tools to track and analyze fixed costs with precision. QuickBooks provides the insights you need to identify trends, pinpoint areas for potential savings, and take control of your financial destiny.