Fixed Expenses: How to Manage Them EffectivelyReading Time: 5 minutes
Managing fixed expenses is a balancing act, and with proper planning, it can become a working ally instead of a burden.
There is always a love-hate relationship with fixed expenses. You know, those pesky bills that show up every month, whether you like it or not. Things like rent, mortgage, insurance, utilities, and salaries.
On one hand, they provide some stability and predictability in budgeting. On the other hand, they can also drain wallets and limit flexibility.
But how can you manage fixed expenses effectively without sacrificing quality of service?
In this blog post, we’ll discuss:
- What are fixed expenses?
- Examples of fixed expenses
- How to calculate it
- Budgeting for fixed expenses
- How to manage fixed expenses
What are fixed expenses?
Fixed expenses, also known as Fixed costs, are regular and predetermined costs that typically remain the same from month to month.
Unlike variable expenses, which can fluctuate based on usage or other factors, fixed expenses do not and are usually necessary for maintaining a certain standard of business operations.
Identifying them and budgeting accordingly is crucial to running a successful business.
Examples of fixed expenses
Small businesses have a variety of fixed expenses, and the specific types can vary depending on the industry and business model. Here are some common examples:
- Rent and utilities: Office space, retail space, or manufacturing facilities, along with utilities like electricity, water, and waste removal.
- Salaries and benefits
- Loan payments
- Equipment leases: Some businesses lease equipment rather than purchase it outright.
- Software subscriptions
- Professional services: Depending on the business, services like accounting, legal advice, or IT support might be outsourced and paid for regularly.
- Taxes and licenses
- Depreciation: While not a cash expense, depreciation reflects the decrease in the value of assets over time and is factored into accounting as a fixed expense.
How to calculate fixed expenses
There are two methods:
Add up Fixed Costs/Expenses
Add up all the individual fixed costs from a list of expenses.
For example, if a business pays $3,000 for rent, $80,000 for salaries, $2,000 for utilities, and $200 for monthly insurance, the total fixed expenses are $85,200.
Subtract the total variable costs from the total costs
A coffee shop has a total monthly expense of $10,000. Their variable costs per cup of coffee are $0.50, and they sell 1,500 cups monthly.
Using the formula:
- Fixed costs = $10,000 total expenses – ($0.50/cup * 1,500 cups) = $10,000 – $750 = $9,250
Budgeting for fixed expenses
Fixed costs are often seen as enemies; however, they are allies that help the smooth running of the business.
The trick is to manage them effectively without sacrificing business finances. Here are helpful tips to budget for fixed expenses, turning them from a burden into a working ally.
Identify and categorize business expenses
Periodically review the previous financial period, analyzing income and expenses.
This will help better understand the financial situation and guide informed decisions.
While reviewing business expenses, identify fixed (e.g., rent, insurance) and variable (e.g., Gas, travel, entertainment) costs.
By identifying and categorizing these expenses, you can get a clear picture of where you may be overspending, which can help you find ways to cut back and save money.
Calculate projected revenue
To calculate the projected revenue for the next period, analyze sales history, including past revenue, sales volume, and customer behavior.
Also, study the market trends and identify potential opportunities and threats that may impact revenue. This includes analyzing the competition, market demand, and industry regulations.
Finally, it’s best to set growth goals and objectives, considering business strategy, budget, and resources available to reach those goals.
Make a list of Fixed Costs/Expenses
When managing a business, knowing and clearly understanding fixed costs is essential, as you can plan accordingly.
You need to estimate how much you need to pay for each category. For instance, calculate rent by looking at the lease agreement. For salaries, you can add up the wages of all employees. Depreciation is a little more complicated. However, you can estimate the annual depreciation by dividing the asset’s cost by its useful life in years.
Once you have these estimates for each category, you can budget for their expenses and ensure enough cash flow to cover them.
Keep an eye on variable expenses
It’s crucial not to overlook variable expenses when budgeting for fixed costs.
While variable expenses generally don’t directly change the allocated amount for your fixed cost budget, they can indirectly impact it in several ways.
Add up your variable costs and estimate how much they will change based on different business scenarios, like increased sales or slower periods. This will give you a better idea of how these expenses will affect your revenue and help you plan accordingly for your fixed costs.
Other things to consider:
- Forecast any extra spending, such as taxes, loan payments, equipment purchases, or emergencies. Include a contingency fund to cover unexpected costs.
- Analyze cash flow and determine how much money is available to cover expenses and achieve financial goals. Compare projected income and expenses and calculate net profit or loss.
- Apply the budget and stick to it. Track actual income and expenses and compare them with the budget. Identify any variances and analyze the reasons behind them. Make adjustments where necessary to stay on track and improve financial performance.
How to manage fixed expenses
Here are some strategies to consider:
Track & Analyze
Gather a comprehensive list of all regular, non-variable costs like rent, utilities, salaries, and subscriptions. Categorize them as “essential” (crucial for operations) and “non-essential” (potentially cuttable).
Analyze past data to identify trends and areas for improvement. Project future expenses based on this analysis to create a realistic budget for the coming months or years.
This foundation of knowledge empowers you to optimize your expenses without compromising business finances.
The owner of a coffee shop identifies the following expenses:
- Rent: $2500/month (essential)
- Utilities: $500/month (essential)
- Salaries: $3000/month (essential)
- Coffee bean subscription: $200/month (essential)
- Music streaming service: $50/month (non-essential)
- Software for scheduling: $40/month (essential)
- Online advertising: $150/month (non-essential)
The owner reviewed past bills and noticed a 10% increase in utility costs over the last year. They anticipate a 5% rent increase in the coming year and project total fixed expenses for the next year to be $8,540/month.
By carefully tracking and analyzing, a coffee shop owner identified $50/month in savings by canceling a music streaming service and another $50/month by negotiating a lower rate for online advertising.
This proactive approach helped implement cost-saving measures to maintain financial stability and support potential growth.
Optimize & Negotiate
Review contracts for rent, utilities, insurance, and other services.
Don’t be afraid to discuss renegotiations and explain why you are asking for lower rates, better terms, or loyalty discounts.
Make it a duty to always compare prices and services from different providers for things like internet, phone, and other business necessities and regularly review unused or underutilized subscriptions and memberships to eliminate unnecessary costs.
Be Efficient & Automate
Look for ways to streamline internal processes for increased efficiency. Automation can be a powerful tool, reducing manual labor and associated costs. For example, an online ordering system can manage the process of customers placing orders through a user-friendly website or app, eliminating phone calls and manual order taking.
Also, implementing energy-saving measures like LED lighting, smart thermostats, and power-efficient appliances can reduce energy consumption and expenses.
Another way would be to utilize software and tools to automate payroll, scheduling, and inventory management, freeing up resources and reducing overhead costs.
Make Strategic Adjustments
Not everything needs to be done in-house. Outsourcing non-core tasks like accounting, marketing, or even IT to specialists can be surprisingly cost-effective compared to maintaining full-time staff.
Also, consider alternative staffing models like hiring part-time or freelance help for seasonal demands or specialized projects. This offers flexibility, reduces fixed costs associated with full-time employees, and lets you quickly scale up or down as needed.
Remember, the goal is to streamline operations and optimize expenses without compromising core value propositions.
Managing fixed expenses is crucial for achieving financial success in business. To do this effectively, it’s important to identify and categorize business expenses, calculate projected revenue, list fixed costs, and monitor variable expenses.
This will help ensure enough cash flow to cover necessary costs while allowing flexibility in other budget areas.