Fixed Cost vs. Overhead: Understanding the Differences
Fixed costs are a type of expense that remains constant regardless of the level of production or sales. They do not vary with changes in output or activity levels. Examples of fixed costs include rent, salaries of permanent employees, depreciation expenses, and property taxes. Fixed costs are necessary to keep a company operating smoothly, but profit margins should reflect these costs. Fixed costs are fairly predictable and should not change from the budgeted amounts allocated for them. However, if sales increase significantly, fixed costs may increase as well due to the need for additional employees or facilities (Investopedia, 2021).
Key Facts
- Fixed costs are expenses that remain constant regardless of the level of production or sales.
- These costs do not vary with changes in output or activity levels.
- Examples of fixed costs include rent, salaries of permanent employees, depreciation expenses, and property taxes.
- Fixed costs are necessary to keep a company operating smoothly, but profit margins should reflect these costs.
- Fixed costs are fairly predictable and should not change from the budgeted amounts allocated for them.
- However, if sales increase significantly, fixed costs may increase as well due to the need for additional employees or facilities.
Overhead:
- Overhead costs, also known as fixed costs or just overheads, are expenses that a company is committed to paying regardless of its output.
- Overhead costs are a subset of fixed costs and are shown in the operating expenses section of a company’s profit and loss account.
- Overhead costs include expenses related to maintaining a workspace, such as rent, utilities, and mandatory insurance.
- Core labor costs are also considered overhead costs because permanent employees must be paid their salary or wage regardless of output.
- Overhead costs can also include contracts for managed services and software licenses.
- Overhead costs can be variable to some extent, such as utility costs that vary according to use.
- Minimizing overhead costs is a priority for companies, and they are becoming increasingly creative in reducing them.
- However, focusing too much on minimizing overhead costs can lead to missed opportunities and reduced profitability.
Overhead Costs: A Subset of Fixed Costs
Overhead costs are a subset of fixed costs and are shown in the operating expenses section of a company’s profit and loss account. Overhead costs include expenses related to maintaining a workspace, such as rent, utilities, and mandatory insurance. Core labor costs are also considered overhead costs because permanent employees must be paid their salary or wage regardless of output. Overhead costs can also include contracts for managed services and software licenses. Overhead costs can be variable to some extent, such as utility costs that vary according to use (Square Business Glossary, n.d.).
Minimizing Overhead Costs
Minimizing overhead costs is a priority for companies, and they are becoming increasingly creative in reducing them. However, focusing too much on minimizing overhead costs can lead to missed opportunities and reduced profitability. Companies need to find a balance between minimizing overhead costs and maintaining the resources necessary to operate effectively (Square Business Glossary, n.d.).
Conclusion
Fixed costs and overhead costs are important concepts in business finance. Fixed costs are a necessary part of operating a business, but they can also be a burden on profitability. Overhead costs are a subset of fixed costs that are specifically related to maintaining a workspace and workforce. Companies need to carefully manage both fixed costs and overhead costs in order to maximize profitability.
References
Investopedia. (2021, May 17). How Are Fixed and Variable Overhead Different? Retrieved from https://www.investopedia.com/ask/answers/033015/how-does-fixed-overhead-differ-varied-overhead.asp
Square Business Glossary. (n.d.). Overhead Costs. Retrieved from https://squareup.com/us/en/glossary/overhead-costs
FAQs
What is fixed cost?
Fixed costs are expenses that remain constant regardless of the level of production or sales. Examples include rent, salaries of permanent employees, depreciation expenses, and property taxes.
What is overhead cost?
Overhead costs are a subset of fixed costs that are specifically related to maintaining a workspace and workforce. Examples include rent, utilities, mandatory insurance, and core labor costs.
How are fixed costs and overhead costs different?
Fixed costs are all costs that do not vary with changes in output or activity levels, while overhead costs are a subset of fixed costs that are specifically related to maintaining a workspace and workforce.
Why is it important to minimize overhead costs?
Minimizing overhead costs can improve profitability by reducing the burden of fixed expenses. However, it is important to find a balance between minimizing overhead costs and maintaining the resources necessary to operate effectively.
What are some examples of fixed costs that are not overhead costs?
Examples of fixed costs that are not overhead costs include research and development expenses, advertising expenses, and interest expenses.
What are some examples of overhead costs that are not fixed costs?
Examples of overhead costs that are not fixed costs include utility costs that vary according to use and the cost of raw materials.
How can companies minimize overhead costs?
Companies can minimize overhead costs by renegotiating contracts with suppliers, reducing energy consumption, and using technology to streamline administrative tasks.
How can companies avoid overemphasizing cost minimization?
Companies can avoid overemphasizing cost minimization by considering the potential impact on customer satisfaction, employee morale, and long-term growth.