Fixed operating expenses are the actual costs associated with operating a property that do not vary in the short term. These costs do not change with a property’s occupancy rate. Property insurance is a common example of a fixed operating cost.
Because these expenses do not fluctuate with business revenue, they are easy to project and budget for. At some point, the business may see an increase in these expenses. However, the increase will be known ahead of time.
Generally, such increases come in stages. For example, the business may have a ten-seat software license that costs $2,500/mo. The business only has eight employees, but at some point, it will need to purchase the next block of licenses. As the business grows and its headcount reaches 11, it will purchase the 15 seat license for $3,500/mo. Its fixed expense has increased, but it will not fluctuate month to month.
While variable expenses also fluctuate with production volume, most fixed expenses will hold steady, as most are not direct inputs for production. Utilities and rent are a couple of other examples of fixed expenses. These expenses are necessary for the business to run but do not change as production changes.
Companies can calculate their fixed cost per unit of production. This ratio helps the company to understand economies of scale. As the company produces more widgets, its fixed cost per widget drops since it doesn’t cost any more to produce an additional fixed widget. In that case, we say the company realizes increasing positive economies of scale.
As mentioned earlier, at some point, the company will need to invest in fixed cost to continue increasing production. This might be higher rent due to a larger space, or higher utility cost due to the cost of more machines.
Economies of scale can also work against the company. If sales drop and the company reduces production, its fixed cost per widget will increase. The company may eventually be forced to lease a smaller space to reduce its fixed cost (i.e., rent).
Fixed expenses can be found in the Sales, General, and Administrative (SG&A) section of the income statement.
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