Every expense in your business behaves in one of two ways. Some stay the same no matter how much you sell. Others go up each time you make a sale. Knowing which is which sounds like a bookkeeping detail, but it decides how you price, how many sales you need to survive, and how much extra profit a good month actually brings.
The Simple Test
Ask one question about each expense: if I sold nothing next month, would I still pay this?
- Yes: it’s a fixed cost. Rent, salaries, insurance, loan payments, software subscriptions.
- No: it’s a variable cost. Materials, packaging, shipping, card processing fees, sales commissions.
“Fixed” doesn’t mean the cost never changes. Your landlord can raise the rent. It means the cost doesn’t change because of your sales volume.
A Bakery Example
Take a small bakery that sells sourdough loaves at $6 each.
| Fixed costs (per month) | Amount |
| Rent | $2,000 |
| Salaried manager | $3,000 |
| Insurance | $300 |
| Software and subscriptions | $100 |
| Total | $5,400 |
| Variable costs (per loaf) | Amount |
| Flour and other ingredients | $1.50 |
| Bag and label | $0.25 |
| Card processing | $0.25 |
| Total | $2.00 |
Each loaf brings in $6 and costs $2 to produce, so it contributes $4 toward the fixed costs. The bakery has to sell 1,350 loaves a month ($5,400 ÷ $4) before it makes a cent. That’s the break-even point, and you can’t calculate it without splitting costs this way. Our guide on how to calculate your break-even point walks through the full method.
The Costs That Are a Bit of Both
Some expenses don’t fit neatly. Electricity has a base charge plus usage that climbs when the ovens run longer. Hourly staff are needed at a minimum level to open the doors, then you add shifts when it’s busy. A delivery van has fixed insurance and variable fuel.
For these, split the bill. Treat the part you’d pay in a dead month as fixed and the rest as variable. A rough split is far better than putting the whole thing in the wrong column.
Why the Split Changes Your Decisions
Pricing. Your variable cost per unit is the floor. Sell below it and you lose money on every sale, and more sales make it worse. Above it, each sale helps pay the fixed bills. For turning costs into a price, see how to price a product.
Profit swings. Because fixed costs don’t move, profit changes faster than sales. If the bakery sells 2,000 loaves, it earns $8,000 in contribution and keeps $2,600 after fixed costs. Sell 20% more, 2,400 loaves, and profit rises to $4,200. That’s a 62% jump from a 20% increase in sales. It works the same way in reverse, which is why a business with high fixed costs feels a slow month so sharply.
Risk. A business with mostly variable costs, like a freelancer or a dropshipper, can shrink its spending when sales fall. One with mostly fixed costs, like a restaurant or a gym, cannot. Neither is better, but you should know which kind you’re running before signing a long lease or hiring full-time staff.
How to Lower Each Kind
- Fixed costs usually come down through negotiation and pruning: renegotiate the lease at renewal, cancel subscriptions nobody uses, share space or equipment.
- Variable costs come down through buying and process: better supplier terms, bulk orders you can actually use, less waste, cheaper payment methods.
A small cut in variable cost is often worth more than it looks, because it repeats on every unit you sell for the rest of the year.
Do This Once
Open last month’s bank statement or your profit and loss statement and mark every expense F or V. Add up the F column for your monthly fixed total, and divide the V column by units sold for your variable cost per unit. Those two numbers feed almost every other calculation in our small business finance basics guide.
