Running a small business can feel like you have to juggle a dozen different balls at once. You have to constantly manage, plan and try to stay one step ahead.
One of the crucial areas that is often overlooked is understanding your costs – especially fixed costs. But here’s the good news: understanding this concept can give you a real advantage in making smarter financial decisions.
By the end of this article, you will not only understand what these costs are, but also how they can impact your business and, more importantly, how you can manage them effectively.
What are fixed costs?
Let’s start with the basics. Fixed costs are the costs that your business incurs and that remain constant regardless of how much you produce or sell. Think of them as the basic costs that you need to cover no matter what.
Unlike variable costs, which fluctuate depending on business activity, fixed costs are more predictable.
Imagine renting an office space. Regardless of whether you visit 100 customers per day or just one, the rent remains the same. This is a classic example of fixed costs. Their persistence can be both a blessing and a challenge.
On the one hand, they make budgeting easier. On the other hand, when business is struggling, they can feel like a bit of a burden.
Common examples of fixed costs
To make this concept clearer, let’s break down some of the most common fixed costs small businesses face:
- Rent or mortgage payments: As already mentioned, your rent is a fixed price. It doesn’t change from month to month, even if your income does. If you own the property, mortgage payments are another fixed cost to consider.
- Salaries: Salaries are usually fixed for permanent employees. Whether business is booming or in a slump, you still need to pay your employees their agreed wages.
- Insurance: Your business insurance premiums are typically fixed for the life of the policy, so there are other constant costs to consider.
- Utilities: While some utility costs may vary (e.g. heating in a particularly cold winter), many are relatively constant — especially if you’re on a fixed tariff.
- Loan repayments: If your company has taken out loans, repayment is usually in a fixed monthly amount, regardless of your company’s business performance.
Why it is important to understand fixed costs
Knowing what your fixed costs are will help you keep your books organized while also allowing you to plan strategically for the future. You see that fixed costs make up a large part of your company’s so-called break-even point.
This is the point at which your total revenue equals your total costs, meaning you are not making a loss, but you are not yet making a profit either.
The higher your fixed costs, the higher your break-even point is. In other words, you need to generate more revenue to cover these costs before you can think about profit.
Understanding this will help you make better decisions about pricing, budgeting, and even scaling your business.
How to manage fixed costs effectively
Managing fixed costs can sometimes seem like a huge task, but with a few strategic steps you can ensure they don’t weigh down your business. Here are some practical steps you can take:
- Negotiate rental or lease terms: If rent is one of your essential fixed costs, you should think about negotiating with your landlord. You may be able to secure a lower price or more favorable terms, especially if you have been a reliable renter.
- Review staffing needs: While it’s important to pay your employees fairly, regularly reviewing your headcount can ensure you’re not overspending. This is not necessarily about job cuts, but rather about optimizing schedules or taking part-time workers or freelancers into account.
- Search for insurance: Insurance is a necessary expense, but that doesn’t mean you should accept the first offer you receive. Shop around to make sure you’re getting the best deal possible, and review your policy annually to make sure it still meets your needs.
- Consider refinancing loans: Interest rates and loan terms are subject to change. If your business has outstanding loans, it might be worth looking into refinancing options to lower your monthly repayments.
- Implement energy saving measures: While some operating costs are fixed, you can still take steps to reduce them. Simple changes like switching to energy-efficient lighting, installing smart thermostats, or even conducting an energy audit can result in significant savings over time.
Your role in pricing strategies
Fixed costs also play a crucial role in pricing your products or services. To set a price that ensures profitability, you must cover both your variable and fixed costs. This is where understanding your break-even point comes into play again.
For example, if your fixed costs are high, you may need to set a higher price to ensure that you not only break even but also make a profit.
However, prices that are too high could deter customers, so it’s definitely a balancing act. When you have a clear picture of your fixed costs, you can make more informed decisions about where to set your prices.
Practical example: A case study on fixed cost management
Let’s take a look at a hypothetical small business to see how understanding and managing these costs can make a real difference.
Case Study: Katie’s Cafe
Katie runs a small, independent cafe in the heart of a busy city in the UK. Her fixed costs include rent, salaries for two full-time baristas, insurance and utilities.
When she opened, business was good and covering fixed costs was not a problem. However, a nearby competitor opened and foot traffic began to slow. Suddenly Katie was struggling to break even.
By carefully examining her costs, Sarah was able to take action. She renegotiated her lease and secured a small rent reduction.
She also adjusted her staffing schedule, reducing hours during quieter times and hiring a part-time employee in place of a third full-time barista. She then invested in energy-efficient appliances, which helped lower her utility bills.
Although these changes did not completely reduce costs, they did make them much more manageable. This allowed Katie to lower her break-even point, giving her more freedom to focus on acquiring customers and increasing sales.
Final Thoughts: The Power of Understanding Fixed Costs
Fixed costs may not be the most exciting part of running a business, but they are one of the most important.
By understanding what they are and how they impact your business, you can take control of your finances, make smarter decisions, and ultimately improve your bottom line.
Remember: The key is not just to know your fixed costs, but to actively manage them and ensure they don’t become an anchor that slows down your business.
This puts you in a much better position to overcome challenges, seize opportunities and successfully grow your business.
