Fixed Expense

Written By:
Adiste Mae

In running a business, you’d notice that certain expenses stay the same no matter how profitable you are.

Even more, you seem to be paying these expenses at regular intervals.

Expenses such as your office’s rent, the salaries of your salaried employees, your internet bill, the interest payments you make on your loans – these are the ones that you regularly pay every month at the same amounts (or if not, at relatively the same level).

These are just some examples of your business’s fixed expenses.

Understanding your business’s fixed expenses is key to knowing what is the minimum revenue you need to generate in order to keep your business running without having to bleed out cash.

You usually won’t know how much revenue you’ll exactly generate until you earn it, but you know how much your fixed expenses would be even before you incur them.

And with that knowledge, you can plan ahead how much you should be earning so that you don’t incur a loss.

What’s an expense?

As defined by the International Accounting Standards Board (IASB) expenses are “decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. ”

This means that anything that decreases your net worth, with or without cash outflow, is an expense.

What is a fixed expense?

A fixed expense (also referred to as fixed cost in accounting) is an expense that remains constant whatever your business’s level of activity is.

Whether there’s an increase or decrease in your sales or production, a fixed expense will remain the same.

It should be noted though that this is in the context that the increases/decreases are within a relevant or reasonable range.

For example, if production increases by 20%, or at a level that is within the capacity of your machinery and equipment, then fixed expenses would stay the same (rent if the assets are rentals, or depreciation expense if the assets are owned).

However, if there is a projected increase in production of 150% of the usual production level, your current machinery and equipment probably won’t be able to handle them all, and as such, you’d either have to rent or buy additional machinery and equipment to accommodate the increase.

Both options come with a corresponding increase in fixed expenses either with rent expense or depreciation expense.

Fixed expenses are the easiest expenses to predict and plan for since you typically know how much you’ll be paying and when you’ll be making such payments.

They are also the hardest expenses to adjust – if you want to reduce them, it often comes with major business decisions (e.g. moving to another location, selecting another security agency, downsizing).

While fixed expenses typically stay the same for a certain period, that doesn’t mean that they can’t change.

They do, but it doesn’t happen too often.

For example, rent payments will remain the same until the end of your lease contract.

If you decide to renew the lease contract, your landlord might decide to increase the rent to account for inflation.

Another would be interest payments on borrowings.

You’d eventually fully pay your loan and with that comes the end of paying for interest expenses.

Another characteristic of fixed expenses, aside from the constant amount of payment, is that they’re usually paid in regular intervals.

Rental payments are paid monthly, salaries are paid bi-weekly or monthly, property taxes are paid annually, depreciation expenses are recorded monthly, etc.

Common examples of fixed expenses

The following are common examples of fixed expenses:

Depreciation and Amortization

Capital expenses are not recognized as expenses outright but are capitalized as assets instead.

The recorded asset is then gradually written off over its useful life.

For tangible assets, the corresponding expense is referred to as depreciation.

For intangible assets, it is amortization.

There are several methods of calculating depreciation, but the most basic way is by using the straight-line method.

Under the straight-line method, depreciation expense is computed by dividing the book value of the capital asset less salvage value over its useful life.

For example, your business acquired a piece of equipment for $40,000 and is expected to be useful for five years with no salvage value.

Using the straight-line method, your business will be recognizing $8,000 depreciation expense per year for five years.

This $8,000 depreciation will remain constant unless you decide to change your depreciation method or if the whole asset has to be written off due to circumstances.

Computing for amortization is the same as computing for depreciation under the straight-line method.

Say your company bought software licenses for $10,000 that will expire in five years.

That would that you’d be recognizing $2,000 amortization expenses every year for five years.

Rent Expense

The payment you make in exchange for utilizing a property or space that you don’t own is referred to as rent expense.

While rent is usually related to properties that you use for an office or a warehouse, it can also be related to the rent of other assets such as machinery and equipment.

Rent is generally unaffected by your business’s level of activity.

For example, imagine your business is a café and you are renting the space where the actual café is located.

Let’s say the rent is $1,500 per month.

No matter how profitable your café is, the rent will remain $1,500/month.

Whether you make $7,000 or $15,000 in sales, you’d still be paying $1,500 for rent.

Some lease contracts have a mix of fixed and variable components though.

For example, a lease contract may require you to pay $1,200 per month and in addition, 7% of your monthly sales.

This type of expense is referred to as a mixed expense (or semi-variable expense) in accounting.

Salaries Expense

This refers to the payments you make to your salaried employees.

It is different from wages that are based on hourly labor.

Salaries are generally fixed and are either paid weekly, bi-weekly, or monthly depending on company policy.

It can fluctuate if a lot of your salaried employees regularly render overtime and are getting paid for it, but salaries, in general, are constant and predictable.

For example, the salary of your plant supervisor will remain the same whether the plant’s production goes up or down.

Another would be the salary of your cashier (if s/he is a salaried employee) will be the same no matter how much sales your store has made.

Fees for contracted services (accounting, security, maintenance, attorney services, etc.)

Businesses sometimes outsource some of their processes, such as accounting, customer service, security, maintenance, etc. rather than employing people to do them.

Payment for these services is typically governed by a contract, stating the fees and the length of the service.

For example, you contracted a security agency to provide security services for your properties.

You are not directly responsible for paying the salaries/wages of the security personnel, but rather the agency.

What you pay instead is the contracting fee stated in the contract between you and the agency.

If one of the security personnel renders overtime (that is outside of your power), you would still be paying the same amount to the security agency.

Interest expense

Interest Expenserefers to the interest payments you make related to your borrowings or loans.

Depending on how principal payments are made (monthly, semi-annually, annually, etc,), the interest expense can fluctuate.

However, it can also be considered a fixed expense because the interest rate and frequency of payments are already determined at the time of borrowing.

For example, you borrowed $100,000 from a creditor.

The terms of the borrowing are as follows:

• The loan is payable in five years;
• Principal payments of $20,000 are to be made on December 1 of each year; and
• Interest payments are to be made on the 5th day of each month at a rate of 1.5% per month.

From the terms above, you’ll be paying 1.5% interest per month, which will form part of your fixed expenses.

For the first year, you’ll be paying $1,500 interest per month.

After the first principal payment, you’ll be paying $1,200 interest per month, and so on.

Reducing your Fixed Expenses

While it isn’t easy to reduce your business’s fixed expenses, it can still be done.

It often comes with major business decisions though, so it isn’t usually done.

However, if you do decide to reduce some of your fixed expenses, even the smallest of adjustments can go a long way.

For example, if you decide to move to another location that has cheaper rent, you’d only have to move once, but the effects can be felt for the rest of your business’s lifetime.

If we add figures to that, let’s say that you’re currently paying $3,500 per month for rent, and then the rent for your new location is $3,000 per month, then that’s equal to $500 per month or $6,000 per year of reduction on your fixed expenses.

Here are other ways to lower your fixed expenses:

• Instead of moving to another location with cheaper rent, you can negotiate for a lower rent with your current landlord

• If there’s an underutilized portion on the space you’re renting that you know you won’t be using in the future, you can sublease it to another business to save on rent

• You can choose to fully repay your loan earlier to save on interest expenses, though this might require approval from your creditor

• You can reduce the number of you salaried employees

• You can shop around for lower insurance premiums

Determining your break-even point

A business’s break-even point is the level of revenue that covers a business’s total costs and expenses.

In other words, it is the minimum revenue that your business should generate so that it doesn’t incur losses.

Any revenue that is above a business’s break-even point will always equate to profits/net income.

Determining a business’s break-even point can be approached in two ways: either determining the number of units that have to be sold, or determining the level of sales (in dollars) that has to be reached.

The first approach is particularly useful if you want to assess the profitability of each of your products.

The second approach is useful if you want to know the minimum amount of revenue you should be aiming for to not incur losses.

Put into formula form:

Break-even point = Fixed Expenses ÷ (Selling price per unit – Variable Expenses per unit)

-or-

Break-even point = Fixed Expenses ÷ Contribution Margin*

*Contribution margin = (Selling price per unit – Variable Expenses per unit) ÷ Selling price per unit

Having an understanding of your business’s fixed expenses will greatly help you in determining your business’s break-even point.

Since these expenses remain the same no matter the level of activity, you can treat them as a base for your business’s break-even point.

For example, if the total for your fixed expenses is $200,000, then you can already tell that your break even-point cannot be lower than $200,000 even if you haven’t determined what your selling price and variable expenses are yet.

Conclusion and takeaways

Fixed expenses are expenses that typically stay the same no matter the level of activity a business has.

They are easy to predict and plan for, as aside from the constant amount of payment, they are also paid in regular intervals.

While fixed expenses generally stay the same, it’s not like they stay the same forever.

Rent may be increased by the landlord, your current insurance premium payments may increase, you’d stop paying interest once the related borrowing has already been fully paid.

Note that these changes are still easy to plan for as they are made known to you before they happen.

Having an understanding of your business’s fixed expenses will make it easier for you to determine your business’s break-even point.

You can already tell that your business’s break-even point cannot go lower than its fixed expenses even without knowing its sales and variable expenses.