A fixed cost stays the same in total when output changes, such as shop rent. A variable cost changes in total as output changes, such as ingredients. In an exam you receive a short case, sort its costs, and then use the sorting in a calculation or an explanation.
This lesson opens costs, revenue and break-even. Every later calculation in the module depends on sorting the costs correctly first.
How do you tell fixed from variable?
Ask one question about each cost: “If the business made 100 more units next month, would this bill change?” If the bill stays the same, it is fixed. If it rises in step with output, it is variable.
Common fixed costs are rent, managers’ salaries, insurance, loan interest and machine rental. Common variable costs are raw materials, packaging, piece-rate wages, sales commission and delivery paid per parcel.
“Fixed” means fixed within the range of output the firm is working at, over the period in the question. Some costs are mixed. An electricity bill may have a fixed monthly charge plus a charge per unit used, so say which part you are treating as fixed and which as variable.
Three formulas link the ideas:
- Total variable cost = variable cost per unit × units made
- Total cost = total fixed cost + total variable cost
- Average cost per unit = total cost ÷ units made
Worked example
Dapur Kak Lina in Seremban sells nasi lemak packets to offices. Each month it pays rent of RM2,400 and a cook’s salary of RM3,600. Rice, coconut milk, anchovies and egg cost RM3.00 per packet, and packaging costs RM0.50 per packet.
Classify the costs, then find total cost and average cost at 2,000 and at 3,000 packets.
Step 1, classify. Fixed: rent and salary, so 2,400 + 3,600 = RM6,000 a month. Variable: ingredients and packaging, so 3.00 + 0.50 = RM3.50 per packet.
Step 2, 2,000 packets. Variable cost = 2,000 × 3.50 = RM7,000. Total cost = 6,000 + 7,000 = RM13,000. Average cost = 13,000 ÷ 2,000 = RM6.50.
Step 3, 3,000 packets. Variable cost = 3,000 × 3.50 = RM10,500. Total cost = 6,000 + 10,500 = RM16,500. Average cost = 16,500 ÷ 3,000 = RM5.50.
Step 4, read the result. Total cost rose by 16,500 − 13,000 = RM3,500 for 1,000 more packets. That is exactly the variable cost of RM3.50 per packet, because the RM6,000 of fixed cost did not move. Average cost fell by RM1.00 because the fixed cost was shared across more packets.
The mistake to watch for
A common slip is to treat fixed cost per unit as if it were a variable cost.
Mistaken working: At 2,000 packets, fixed cost is RM3.00 per packet. So at 3,000 packets, fixed cost is 3.00 × 3,000 = RM9,000.
The student carried the per-packet figure from one output level to another.
The RM3.00 per packet only describes the 2,000-packet level. Total fixed cost stays RM6,000, so at 3,000 packets the fixed cost per packet is 6,000 ÷ 3,000 = RM2.00. The correction is to always return to the total fixed cost and divide again.
Check yourself
Try these on paper, then open each answer.
1. A cafe pays a rider RM2 for each parcel delivered, pays RM1,200 insurance for the whole year and buys coffee beans for each cup sold. Classify each cost.
Show answer
Rider payment: variable, because it rises with parcels. Insurance: fixed, because the bill does not change with output. Coffee beans: variable, because more cups need more beans.
2. A small printer has fixed costs of RM5,000 a month and variable costs of RM4 per item. Calculate total cost for 800 items.
Show answer
Variable cost = 800 × 4 = RM3,200. Total cost = 5,000 + 3,200 = RM8,200.
3. The same printer has fixed costs of RM2,000 a month. Find fixed cost per item at 500 items and at 1,000 items, and explain the change.
Show answer
At 500 items: 2,000 ÷ 500 = RM4. At 1,000 items: 2,000 ÷ 1,000 = RM2. The total fixed cost is unchanged, but it is shared across twice as many items, so each item carries half as much.
Where this leads next
With costs sorted, the next step is to calculate contribution, which shows how much each sale adds towards the fixed costs. When you want to see how the timing of payments differs from the cost itself, the cash versus profit bridge shows the two side by side. Then test the topic with the costs and break-even practice set.
Students who sort costs correctly but lose marks in the written part of the question often need practice linking the sort to the case. That is a good use of time in online one-to-one Business tuition.