What Is the Difference Between Fixed and Variable Cost?

Fixed Cost (also known as fixed cost), relative to variable cost, refers to the cost that the total cost can remain unchanged within a certain period of time and within a certain business volume, regardless of changes in business volume.

Chinese name: Fixed cost
Foreign name: Fixed Cost
nickname: Fixed costs

Applied discipline: Economics; engineering economics
Scope of application: construction project
Scope of application: Road and Bridge Engineering

Introduction to Fixed Cost

Fixed cost characteristics

(1) The total cost does not change with the business volume, and it is expressed as a fixed amount;

(2) The fixed cost of unit business burden (ie, unit fixed cost) changes inversely with the increase and decrease of business volume ^[1] .

Fixed cost range

The total fixed cost is fixed only within a certain period and within a certain business volume range, which means that the fixed nature of fixed costs is conditional. A certain range mentioned here is called a correlation range. If business volume changes beyond this range, fixed costs will change.

Classification of fixed costs

Fixed costs can usually be divided into binding fixed costs and discretionary fixed costs.

Binding fixed cost

Costs that must be spent in order to maintain the ability of an enterprise to provide products and services, such as depreciation of plant and machinery, property taxes, house rents, salaries of management personnel, etc. Because this type of cost is associated with maintaining the company's operating capacity, it is also known as the capacity cost. Once the amount of such costs is determined, it cannot be easily changed and is therefore quite restrictive ^[1] .

Fixed cost discretionary fixed cost

Before the start of the fiscal year, the management of the enterprise determines the fixed costs, such as new product development costs, advertising costs, and employee training costs, that are formed during the planning period based on operating and financial resources. Because the cost of this type of budget is only valid during the budget period, business leaders can determine the budget number of different budget periods according to changes in specific circumstances, so it is also called self-defined fixed cost. The amount of such costs is not binding and can be determined in light of different circumstances.

Comparison of fixed costs

Fixed Cost Traditional Cost Management

Traditional cost management Traditional cost management mainly achieves the purpose of saving expenses and controlling costs through short-term actions such as reducing various service items or contents, reducing the purchase price of raw materials, and reducing explicit expenditures. It essentially uses the "value-added" approach to reduce costs in order to reduce costs, and does not combine cost management with competitive advantage.

Fixed Cost Strategic Cost Management

Strategic cost management Strategic cost management is mainly to dig the hidden costs of the company, to analyze and use the cost information throughout the strategic management, to provide strategic cost information for each key step, to obtain cost advantages from beginning to end, thereby forming a competitive advantage for the enterprise and improving the core Competitive and ahead of the competition. Strategic cost management emphasizes knowing ourselves and knowing each other, revealing the relative cost position of the company compared to competitors, and seeking ways to continuously reduce costs. It can also be said that it is cost management in order to obtain and maintain the sustainable competitive advantage of the enterprise ^[1] .

The main purpose of strategic management of enterprises is to obtain the two keys of growth and return in sustainable development. This is the so-called "require benefits from management." As an important part of strategic management, strategic cost management has replaced traditional cost management and has become an advantageous weapon for enterprises to strengthen cost management and obtain competitive advantages.

Fixed cost method and scope

The basic methods of strategic cost management include value chain analysis, competitor analysis, and strategic cost driver analysis.

Fixed cost value chain analysis

The value chain analysis method is a tool that seeks to determine the competitive advantage of an enterprise. Enterprise value chain analysis is to determine the cost of a company by decomposing its activities, determining costs and benefits based on various value activities, considering individual activities and their relationships, and making tradeoffs and tradeoffs based on the company's strategic goals. Competitive Advantage. When the cumulative total cost of all activities in the enterprise value chain is less than competitors, it has a strategic cost advantage.

Fixed cost competitor analysis

The competitor analysis method analyzes the information and evidence of competitors' value chains, strengths and weaknesses, response models, competitive strategies, and even core competitiveness, considers their position in the competition, and adopts actions and responses to thereby The decision-making of enterprises and the development of business activities provide reference basis.

Fixed Cost Strategic Cost Driver Analysis

Strategic cost driver analysis is to analyze the root cause of cost incurred, so as to control a large number of potential cost problems in the daily operation of the enterprise. Including the analysis of executive cost drivers at the micro level and the analysis of structural cost drivers at the enterprise level ^[1] .

Fixed cost range

Strategic cost management includes fixed cost strategic management and variable cost strategic management . The former is generally understood to be fixed and there is no room for management, let alone from a strategic perspective, so it is not valued by managers. But in fact, from reducing fixed asset investment, making full use of suppliers to asset-light structure; from unreasonable amortization of indirect costs to the use of operating cost method; from expanding production, increasing equipment utilization, over-producing to increasing fixed cost Sales and reduction of unit cost are all manageable, and they are an effective way to establish the cost advantage and core competitiveness of the enterprise. So fixed cost strategic management has new value.

Scientific management of fixed costs

Different industries have different asset investment ratios and different returns. For example, the fixed asset investment in the aviation, post and telecommunications industries is much higher than the corresponding current asset investment; the mining and chemical industries have high investment requirements for fixed assets and current assets; industries with large current asset investments are mostly concentrated in In the field of consumer goods; the retail industry generally does not have high requirements for investment in fixed assets and current assets. At the same time, the return on equity tells us: between different industries, there is no significant correlation between investment and returns; and in the same industry, fixed asset investment and returns are generally related. Facts can prove that we can also predict that the larger the fixed asset investment, the more amortized fixed costs per unit product, the higher the total cost per unit product, the lower the profit, and the lower the return on investment. Among them, the measure is the turnover rate of fixed assets. For enterprises, the way to make up for the large investment in fixed assets but bring low returns is to produce products with high added value (high prices) and obtain higher labor productivity. However, due to the fierce competition in industries with large fixed asset investment (such as star-rated hotels and aviation), it is not feasible to raise prices. Therefore, to increase returns, obtain growth, and increase labor productivity, tapping human potential is the main business approach. The key strategic approach is scientific design and reasonable reduction of fixed asset investment.

Fixed-cost asset-light structure

Don't blindly seek for big advances in fixed asset investment, and under the premise of ensuring science and reasonableness, keep fixed asset investment costs to a minimum, reduce the share of fixed costs in total costs, and increase the contribution to profits. Achieve cost-driven investment scale and gain cost advantages. E.g:

(1) Every small link must be considered for new investment. Every time Toyota Motor Corporation invests in a new automobile production plant of the same size in the world, the investment amount of the previous automobile plant is at least 10% less. Therefore, the gross profit margin of Toyota Motor Corporation in 2002 was the highest in the global automotive industry, reaching 8.5. %; And GM only 1.5%. When designing the new plant, Toyota has comprehensively considered every link that requires 'spending money', including the plant, equipment, production processes, and layout. Especially in logistics, every link from raw materials to finished products is scientifically designed to save time and efficiency. According to statistics, a screw from a Toyota auto factory was moved 25 kilometers from the factory to the factory after assembly.

(2) In terms of equipment investment, there is no need to pursue the so-called reputation. As long as it is suitable, domestically produced ones need not be imported. For example, a private paint company spent 2 million yuan to purchase a set of equipment from China, while a listed company purchased 11 million yuan to purchase a set of equipment of the same size from abroad. Isn't this a joke about shareholders' money?

(3) The function of the device is subject to application. It does not pursue redundant functions and luxury. For example, the electrical control system of cement production equipment should be able to adapt to high-temperature dust environment, low failure rate, and easy operation as its main functions. It is also a production line with a daily output of 1,000 tons of cement. A company in Gansu invested 70 million yuan to buy equipment, while a company in Shaanxi invested 130 million yuan. The electrical control system uses technology applied to the US space shuttle. Imagine, in a cement production enterprise, is it necessary to have such advanced technology as aerospace control?

(4) The imported equipment is mainly mature and easy to master and operate. Combined with the actual control level of the company's own engineers, technicians, and workers, it is not appropriate to choose the most advanced and yet popular new equipment. Countless cases of failure in this regard. A beverage company purchased the most advanced equipment from abroad. Due to the difficulty in operating the technology, the company spent nearly two years in commissioning and eventually failed to reach its design capacity.

(5) Does the plant choose a steel-concrete brick structure or a steel structure? Even light steel structures in steel structures? Enterprises can reduce the amount of steel and reduce the amount of investment through reasonable design and feasibility studies.

(6) Reasonable use of fixed asset leasing business. Regardless of short-term or long-term use, the plant and equipment can take the form of lease, especially the equipment with low efficiency. For example, leasing is commonly used for large-scale construction equipment. After the construction of the Taiwan high-speed railway and the Hong Kong airport, Hong Kong and Taiwan businessmen leased a large amount of used construction machinery and equipment to the mainland and Thailand for use. This is a normal phenomenon in more developed regions.

(7) It is also necessary to deal with idle assets of enterprises in a timely manner. Although this will cause current one-off losses, it can bring cash recovery for the company, increase operating cash flow, and reduce future depreciation.

(8) In addition, investment in the establishment of large-scale factories can gradually make funds available as needed, and there is no need to complete the investment once. Because investment projects are prone to sunk costs, once the project is established and the investment is completed, there is no turning back. And the investment of funds in stages and in batches, there is the possibility of regular review, to ensure that no possible losses occur or minimize the losses that have occurred. For example, the Chrysler Automobile Company in the United States has only 35% of self-made parts, and the rest are Volkswagen Packages (OEM).

The domestic Mengniu dairy industry is a typical example of adopting an asset-light structure. Mengniu started from scratch, and after 4 years, sales revenue reached more than 2 billion. Their approach is to invest limited funds in key equipment related to core technology; while the more than 500 vehicles needed for supporting them are all invested by the suppliers themselves, and all the assets required by farmers to raise cattle are also invested by farmers themselves Enterprises have no major burdens, and thus achieve faster development than competitors in the same industry.

From the perspective of fixed asset investment, the corresponding strategic management indicators that companies need to consider include: the relationship between business and scale, the degree of integration of internal and external resources of the enterprise, the cost reduction indicator brought by learning, the location selection indicator, and the supplier management indicator. Wait.

Fixed costs increase fixed asset utilization

As we all know, in the cost structure, the greater the proportion of fixed costs, the greater the impact of the efficiency of the use of fixed assets on unit manufacturing costs. For example: the ratio of fixed costs and variable costs in the automobile and parts industry is approximately 10:90; the ratio of fixed costs and variable costs in steel, cement, garden machinery, tomato food, sugar and other industries is approximately 20:80; fruit juice drinks The ratio of fixed costs to variable costs is about 52:48; and the ratio of fixed costs to variable costs in the water industry is about 98: 2. The higher the utilization rate of fixed assets, the faster the turnover, and the stronger the profitability of the enterprise.

For example, although a small steel company has backward equipment, its profitability is very strong. After research, it is found that the actual output of the company exceeds 2.2 times the design capacity, which means that the output of one set of equipment of this company is greater than the output of the second set of equipment of other steel companies, which is equivalent to saving investment in a set of equipment. . The ratio of average fixed costs to variable costs for steel companies is about 20:80, but this company has reached 11:89. The unit manufacturing cost is 90 yuan / ton lower than the industry average. This contribution is mainly due to the company's contribution to fixed assets. management.

Another example: the production of tomato sauce, sugar and other products is very seasonal. There is only a production period of 2-3 months in a year, and the equipment is idle at other times. However, through research and development, cultivating early or late-maturing tomato varieties, starting 10 days in advance or ending production 10 days in advance, can increase the output of tomato sauce by about 14,000 tons, and the cost of each ton of tomato sauce reduced by depreciation of fixed assets is 10 yuan, then the output of 300,000 tons can reduce costs by about 3 million yuan. In addition to idle equipment that can be reused in various ways, relying on the flexibility of production equipment can also improve the utilization of equipment. Shanghai General Motors' car assembly production line is flexible. Buick Regal series, Sail series, GL8 business car series, and new car Excelle series can be assembled on the same assembly line.

For another example, by simulating a small auto parts company, under the existing conditions, the turnover rate of total assets (including fixed assets and current assets) will accelerate, and the growth rate of profits will be faster.

From the perspective of improving the use efficiency of fixed assets, the corresponding strategic management indicators that enterprises need to consider include: production capacity utilization mode indicators, internal organization efficiency indicators, and product development indicators.

Manage and analyze fixed costs from the perspective of production

In fact, it is difficult to analyze and account for fixed costs from the perspective of strategic management. Most of the traditional fixed costs use analysis methods such as cost, volume, profit and loss, and inaccurate data, which is why management accounting methods are rarely used in practice.

Fixed costs (expenses) do not only refer to depreciation. Because fixed costs are included in the indirect cost account in China, when performing traditional costing, they are often calculated based on output. Even if some equipment is not in use, its depreciation is amortized into the cost of the product. This just hides the truth of the actual cost of the product, so it is easy to be ignored and the manager is neglected. If the activity cost method is used for calculation, the actual cost is allocated to the actual behavior or operation according to the equipment hours and labor, which can make up for this shortcoming.

For example, the efficiency of an agricultural machinery production company has been declining year by year, and its losses have been severe. According to traditional accounting analysis, like most companies' reasons for loss: market slump, competition is too fierce, raw material prices, 9/11, atypical pneumonia, Iraq war, etc. But after reassessing the attributes of manufacturing costs using the activity-based costing method, the truth of the facts will be discovered.

It turns out that the fundamental problem of this company is the irrational product structure, too low equipment utilization, too frequent production replacement, long production preparation time, small single product output, low product output value, and low labor productivity that cannot make up for the relative With high fixed costs, the product is essentially the product that developed countries first transferred to developing countries.

From the perspective of fixed costs in production, the corresponding strategic management indicators that enterprises need to consider include output rate indicators, unplanned shutdown indicators, machine-hour occupancy indicators, production preparation time and manpower, product qualification rate indicators, and procurement quality qualification rates And supply time rate indicators.

Fixed cost A cost that an enterprise incurs at a certain period of time, even when the output is zero. Total fixed costs consist of contractual expenses such as interest expenses, mortgage expenses, and manager's fees.

Fixed cost means that the total cost of this part of the cost is fixed in a certain period of time, but the cost allocated to the unit output changes as the output changes.