What Is Fixed Overhead vs. Variable Overhead?

Fixed overhead represents a consistent cost that does not change with the level of production or sales volume over a relevant period. It is an indirect cost essential for a business’s operations, regardless of how much it produces. This article distinguishes fixed overhead from variable overhead and highlights its role in business operations.

Understanding Fixed Overhead

These costs are necessary to keep the business operational and typically recur on a regular basis. They are considered time-based rather than directly tied to activity levels.

Examples of these predictable expenses include the rent paid for a factory or office space, which remains the same each month regardless of output. Insurance premiums for liability, property, or workers’ compensation are also fixed costs, as they are typically paid consistently over a period. Salaries for administrative staff, such as human resources, accounting personnel, or executive management, fall into this category because their compensation does not fluctuate with production volume. Depreciation of equipment is another common fixed overhead expense. Property taxes, usually assessed annually, also represent a fixed cost for the business.

Fixed Overhead Versus Variable Overhead

Fixed overhead is distinct from variable overhead, which changes in direct proportion to the level of production or sales volume. While fixed costs remain stable, variable costs fluctuate with business activity. For instance, if production increases, variable overhead costs rise, and conversely, they decrease with reduced output.

Examples of variable overhead include the cost of raw materials directly used in manufacturing a product. Direct labor wages tied to output, such as piece-rate pay, are also variable. Sales commissions, paid as a percentage of sales, are another example. Unlike fixed overhead, if production or sales halt, variable overhead costs would essentially cease.

The Role of Fixed Overhead in Business Operations

Understanding fixed overhead is important for businesses to grasp their overall cost structure and ensure financial stability. These costs are a necessary component when calculating the total cost of operations, providing a baseline expense that must always be covered. Proper identification of fixed overhead assists in budgeting, allowing businesses to forecast and allocate funds for these predictable expenses.

Fixed overhead is also relevant to the “break-even point,” the sales volume required to cover all costs. These fixed expenses must be met regardless of sales, meaning a business needs to generate enough revenue to cover its fixed overhead before generating a profit.