Fixed and Variable Expenses in Business Budgets
Getting ready to do a budget for your business for startup or just general use to keep track of your business? One of the critical parts of that budget is your listing of fixed and variable expenses. In this article, we'll look at the overall budget and how to separate out those fixed and variable expenses, and how to understand their value.
Creating a Business Budget
A budget is really two different financial statements. Let's assume a monthly budget. Budget A shows the ideal, what you would like every account to look like for the month. Budget B is the actual, what has really happened during the month.
The interesting thing about budgets is that they are almost always wrong, but they almost always turn out right. What I mean is that individual categories often don't come out like you thought they should - the actual may be higher or lower than what you budgeted. But overall, the amounts even out. Funny how that works.
Every business budget has two parts:
- Income or revenue. This is the amount you are estimating will come into your business during the month in sales of products or services.
- Expenses. These are the amounts you are budgeting for what you spend in each category. The expense part of the budget is the most important, because you may not be able to control sales, but you can control expenses.
Including Fixed and Variable Expenses in Your Business Budget
When you get ready to work on your budgeted and actual business expenses, you need to break them down into the categories of fixed expenses and variable expenses.
Fixed expenses are, well, fixed. They are the same every month. But, more important, fixed expenses must be paid every month, no matter what. If you don't have the income to pay these fixed expenses, you will have to find the money somewhere. Fixed expenses include items like:
- Lease or a mortgage.
- Other capital expenses, like the cost of buying business assets - equipment, vehicles, furniture.
- Payments on business loans.
- Utility payments, including phone costs.
- Cost of maintaining a web page (depending on your business type)
- Insurance costs
- Sales expenses, like credit card fees
- Any monthly membership you think you can't live without (your online accounting system, for example)
Think of fixed expenses like this: If I didn't have enough income for a couple of months, which of these could I give up or get out of? Could I cancel a lease and work at home?
Variable expenses are those business expenses which vary depending on the volume of business, sales, or the volume of transactions.
Examples of variable expenses include:
Combination fixed and variable expenses. You might find that some expenses are both fixed and variable. The pay of a salesperson might include a fixed portion (the base salary) plus a variable portion (the commissions on sales).
Are Variable Expenses Discretionary?
Another way to look at variable expenses is that they are discretionary expenses. By definition, if something is discretionary, it's optional, not required. But are there really any discretionary expenses in a business? Look at the list of variable expenses above:
- Donations aren't required, but most businesses will make donations to charities, not only for tax savings but also for public relations purposes.
- Gifts to employees create employee goodwill and keep good employees, while gifts to customers for some businesses are just part of doing business.
- Employees must be trained if they are effective.
- Advertising and publicity are required to get the word out about your products and services.
The only thing discretionary about these expenses is the level. If your business cash flow is low, you may be able to cut back on donations, but levels of expenses are somewhat discretionary. Be cautious when committing to expenses that might seem variable; you may not be able to get rid of them quickly or easily.
Are Employee Expenses Fixed or Variable?
If you have hired a full-time employee who has the expectation of a full-time job, you have probably created a fixed expense, at least in the short term. It's better to hire independent contractors or freelancers while you are starting out, to avoid having the fixed expense of an employee.
The Most Important Thing to Remember about Fixed and Variable Expenses
Keep your fixed expenses as low as possible and don't commit to so-called variable expenses, especially when you are starting your business. During the first year or so of startup, your business income may be low as you build up your customers. Some months you may not have enough to pay your bills. Having fewer fixed expenses will keep you in business until sales start to pick up. Having too many fixed expenses may mean you will have to make some choices, give up some employees, get a loan (another fixed expense) or, unfortunately, close your doors.