What is Fixed Expenses? In the book of Genesis, God said, “Let yourainer know thyself, and thy debtor knows himself.” In business, the term “fixed expense” describes any expense not determined based on a sales price or expected profit at the time of the expense. Examples of fixed expenses in business include supplies, which are recurring monthly costs.
In accounting and economics, fixed expenses, also called overhead or indirect expenses, are non-specific business costs that are not directly related to the quantity of products or services sold by the firm. They are usually recurring, including rent or interest being paid each month. A prime example of a fixed expense is the cost of employing and training an employee. Although this cost may not be determined until the employee has been employed for a certain period of time, it is a fixed cost because it will not change unless the firm increases its prices or reduces its workforce. Indirect costs are costs that affect the supply of a product or service before it is sold to the customer. Examples of indirect costs are advertising and promotional expenses.
Both indirect and fixed expenses have a direct relationship with sales, production and profit. Indirect costs are economic or non-monetary costs that are unrelated to the sale of a product or service to the customer. Examples of these costs are transportation, overhead and information technology. A fixed expense is a specific monetary cost that is determined at the time of a transaction, rather than an estimate of future costs.
A fixed price contract, for instance, is one where there is a pre-determined price for a fixed number of deliveries over a definite period of time. The price is often determined by a party to the contract. In such contracts, a fixed expense is a cost that is predetermined and does not vary because of fluctuations in market conditions. A fixed price is usually a fair price that is free of abusive proactive pricing practices. Some fixed expenses consist of a minimum order quantity; a delivery commitment; or a level of quality assurance that must be maintained.
Fixed prices that are set at the time of a transaction are called fixed expenses. An example of a fixed price contract is a lease purchase agreement. In this case, both parties agree that at the end of the term of the lease (the term), neither party is responsible for additional fees unless specified in the rental agreement. Fixed expenses consist of the price specified in the contract, as well as any amounts that would be assessed but not taken in consideration by the parties due to a change in the price or economic circumstances. Examples of fixed expenses include salaries, labor and material costs.
A variation on the above example could be a fixed rate loan, where the rent would remain the same over the term of the loan (even if market conditions have changed). A variation to this example would be a balloon mortgage where the balloon payment at the end of the loan term is paid in full. Both examples share the element of a fixed price established at the time of the transaction, with fixed expenses continuing through the end of the period. This is a very important concept because it ensures that fixed expenses will not be out of sync with the variable costs that tend to occur in a typical commercial real estate transaction. If fixed prices cannot be established at the time of the transaction, it is imperative that careful negotiations take place before the transaction closes to ensure that fixed expenses do not exceed variable costs.
The relationship between fixed and variable costs is a complex one. It is sometimes difficult to discern what is fixed and what is variable. The answer really depends on your situation and goals. For example, a fixed cost loan that pays a constant interest rate over the life of the loan term is definitely a fixed expense. However, if the interest rate drops below the fixed rate loan-term at any time, the lender must determine if the drop is justified by the lower interest rate and add that to the variable interest expense.
Some fixed expenses are guaranteed to exist at every point in the funding process. These are payments made to the lender on behalf of the borrower at the time of the loan. Examples of these include appraisals and inspections. Other expenses are administrative and preparation costs. Regardless of how you choose to finance your business, the ultimate goal is to minimize your fixed expenses while maximizing your potential for growth. Understanding your financing options and working within your means is the best way to accomplish this.