Don’t Believe the Fixed Cost Lie

Everyone loves to quote fixed costs when trying to get investors to invest or when trying to predict potential profitability. That’s because fixed costs seem nice and predictable. Since they aren’t impacted by customer fluctuations, they make for easy calculation. Unfortunately, many costs that we called “fixed” aren’t actually fixed.

Sure, in the short term they remain relatively flat. But in the long term they are not. They are stepped. Rent, telephones, and staff salaries are three good examples of costs once thought to be fixed but which really are variable. They increase to a point then remain flat for a period of time and then increase again. Your rent, for example, will remain flat until you need to add more office space. Your telephone costs will remain flat until you need to add more phones or you suddenly get a bunch of clients in Mongolia and you have to start calling overseas. Your staff salaries remain fixed for as long as you pay them that wage but they will rise with cost of living allowances, raises, and staff increases. Any of these fixed costs located in a different county will have the added variable of currency fluctuation. Even inflation can drive up your fixed costs by an average of 3% per year. (If everything else rises at the same rate then it doesn’t matter but often businesses will hold prices firm until they have to catch up so the result to your business is an increase in fixed costs by about 3% per year.)

So what should you do?
Even if you’ve outsourced your bookkeeping and accounting, it doesn’t hurt to know that your fixed costs are really stepped costs. Knowing this will make a huge difference in your forecasting and in the accuracy of profitability predictions.

Chances are, you’ve identified fixed costs in financial plan and they are part of the economic assumptions you have about your business. But since you now know that they aren’t truly fixed, take a moment to review them and answer the following questions:

• What will impact the rise of each fixed cost? (Currency fluctuations? Additional clients? Additional staff? Etc. Or some combination?)

• What is the amount of impact required for each fixed cost to rise? (Maybe an additional 10 clients won’t change your costs but maybe 100 new clients will. Figure out what that point is where resources are taxed to the limit and more is required).

• What is the frequency of “steps” in these stepped costs? Is it every 100 customers that you require another staff member? Maybe it’s not that simple. You need to estimate at what point will each step be triggered.

What do to after you’ve done that
Now that you’ve done that simple exercise, look at the list of impacts and steps. Those are your business growth milestones that will change your business’ financial picture. In some cases, you can mitigate some of those changes by building in systems and processes and technology. In other cases, the rising costs will be inevitable. It’s worth thinking about each one and what you can do about it.