What are fixed costs?

Running a small business can feel like juggling a dozen different balls at once. You’re constantly managing, planning, and trying to stay ahead of the game.

One of the crucial areas that often get overlooked is understanding your costs—especially fixed costs. But here’s the good news: grasping this concept can give you a real edge in making smarter financial decisions.

By the end of this article, you’ll not only understand what these costs are but also how they can impact your business and, more importantly, how to manage them effectively.

What are fixed costs?

Let’s start with the basics. Fixed costs are the expenses your business incurs that remain constant, regardless of how much you’re producing or selling. Think of them as the baseline expenses you have to cover, no matter what.

Unlike variable costs—which fluctuate based on your business activity—fixed costs are more predictable.

Imagine you’re renting an office space. Whether you’re seeing 100 clients a day or just one, that rent stays the same. This is a classic example of a fixed cost. Their consistency can be both a blessing and a challenge.

On the one hand, they make budgeting easier. On the other hand, they can feel like a bit of a burden when business is slow.

Common examples of fixed costs

To make this concept clearer, let’s break down some of the most common fixed costs small businesses face:

1. Rent or mortgage payments: as mentioned earlier, your rent is a fixed cost. It doesn’t change month-to-month, even if your income does. If you own the premises, mortgage payments are another fixed cost to consider.
   
2. Salaries: for permanent staff, their salaries are usually fixed. Whether business is booming or in a lull, you still need to pay your employees their agreed-upon wage.
   
3. Insurance: your business insurance premiums are typically fixed for the term of the policy, providing another steady cost to account for.
   
4. Utilities: while some utility costs can vary (like heating during a particularly cold winter), many are relatively consistent—especially if you’re on a fixed plan.
   
5. Loan repayments: if your business has taken out loans, repayments are usually a fixed monthly amount, regardless of how your business is performing.
   

Why understanding fixed costs matters

Knowing what your fixed costs are helps to keep your books tidy, while also helping you strategically plan for the future. You see, fixed costs are a big part of what’s known as your business’s break-even point.

This is the point at which your total revenue equals your total costs, meaning you’re not making a loss, but you’re not making a profit yet either.

The higher your fixed costs, the higher your break-even point. In other words, you need to bring in more revenue just to cover those costs before you can start thinking about profit.

Understanding this helps you make better decisions about pricing, budgeting, and even scaling your business.

How to manage fixed costs effectively

Managing fixed costs can sometimes feel like a huge task, but with a few strategic moves, you can make sure they don’t weigh down your business. Here are some practical steps you can take:

1. Negotiate rent or lease terms: if rent is one of your significant fixed costs, consider negotiating with your landlord. You might be able to secure a lower rate or more favourable terms, especially if you’ve been a reliable tenant.
   
2. Review staffing needs: while it’s important to pay your employees fairly, regularly reviewing your staffing levels can ensure you’re not overspending. This doesn’t necessarily mean cutting jobs but rather optimising schedules or considering part-time or freelance workers.
   
3. Shop around for insurance: insurance is a necessary expense, but that doesn’t mean you should accept the first quote you get. Shop around to ensure you’re getting the best deal possible, and review your policy annually to make sure it still meets your needs.
   
4. Consider refinancing loans: interest rates and loan terms can change. If your business has outstanding loans, it might be worth looking into refinancing options to lower your monthly repayments.
   
5. Implement energy-saving measures: while some utility 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 lead to significant savings over time.
   

Their role in pricing strategies

Fixed costs also play a crucial role in how you price your products or services. To set a price that ensures profitability, you need to cover both your variable and fixed costs. This is where understanding your break-even point comes back into play.

For example, if your fixed costs are high, you may need to set a higher price to ensure you’re not just breaking even but making a profit.

However, pricing too high could start to deter customers, so it’s definitely a balancing act. By having a clear picture of your fixed costs, you can make more informed decisions about where to set your prices.

Real-world example: A case study in fixed costs 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 coffee shop

Katie runs a small, independent coffee shop in the heart of a busy UK town. Her fixed costs include rent, salaries for 2 full-time baristas, insurance, and utilities.

When she first opened, business was brisk, and covering her fixed costs was no issue. However, a nearby competitor opened, and foot traffic began to slow. Suddenly, Katie was struggling to break even.

By closely examining her costs, Sarah was able to take action. She renegotiated her lease, securing a small reduction in rent.

She also adjusted her staffing schedule, reducing hours during quieter times and hiring a part-time employee instead of a third full-time barista. Then she invested in energy-efficient appliances, which helped lower her utility bills.

These changes didn’t eliminate the costs entirely, but made them a lot more manageable. As a result, Katie was able to lower her break-even point, giving her more breathing room to focus on attracting customers and boosting revenue.

Final thoughts: The power of understanding fixed costs

Fixed costs might not be the most exciting part of running a business, but they’re 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 what your fixed costs are, but to actively manage them, making sure they don’t become an anchor dragging down your business.

This will put you in a much better position to navigate challenges, seize opportunities, and grow your business successfully.