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.
You'll need to separate out fixed vs. variable costs if you are preparing a break-even analysis. This chart shows prices and sales volume for a product and the point at which the product become profitable.
Fixed and Variable Expenses Explained
Businesses separate out costs for budgeting and other purposes based on how important it is that they be paid:
Fixed costs must be paid, even if you don't have any sales. For example, you must pay the rent on you business location, the utilities, and you must make the payment on your business loan.
Variable costs change with the amount of products or services you sell. For example, shipping costs, costs for raw materials, or for employees who are making and shipping products or providing services are usually variable.
In The Short Term, All Costs are Fixed
Here's an example: 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.
Creating a Business Budget
A budget for a business 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.
Business budgets are sometimes called operating budgets that look at your business operations, in terms of revenue and expenses over a period of time.
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.
Before you set up your budget, SCORE suggests that you include key assumptions about the products or services you are selling and key drivers (priorities) for expenses.
Including Fixed and Variable Expenses in Your 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 might include:
- 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?
Examples of variable expenses include:
- donations to charities
- gifts to employees and customers
- employee training
- advertising and publicity.
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).
Variable Expenses Are 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? For example:
- 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 to be 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.
The Most Important Thing to Remember About 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.