What distinguishes fixed costs from variable costs?

Fixed costs are characterized by their stability regardless of the level of production or sales, which means they remain constant over a relevant range of activity. This could include expenses such as rent, salaries of permanent staff, and insurance. These costs do not change when production increases or decreases, making them predictable and easier for businesses to plan for financially.

In contrast, variable costs fluctuate in direct proportion to changes in production levels. This means that as more products are made, variable costs—like direct materials, hourly wages for labor, and utilities tied to production—will increase. Conversely, if production declines, these costs decrease accordingly.

Understanding this distinction is vital for businesses in budgeting, cost control, and pricing decisions, as it influences profit margins and the overall financial health of an organization. Therefore, recognizing that fixed costs remain stable while variable costs change with production levels is fundamental to sound financial management.