Fixed costs which are project or company operational costs whose amount does not change in stable business conditions. One of the important aspects so that the company's bookkeeping or budgeting can be done correctly is knowing in detail all expenses that are fixed costs. That way, you can set up funds to pay the same amount every month to increase operating profit. In general, the budgeting of fixed costs is done for the short term (6-12 months) because any costs can change at any time. In addition, you should also find out the fixed costs that will be burdened by the company for a year.
Notes: Fixed costs are commonly called “indirect costs” or “overhead costs”.
Step
Method 1 of 2: Knowing the Fixed Costs of the Company
Step 1. Record all costs for a given period
The period that is often used as the basis for determining company costs is quarterly (three months). If you haven't had time to collect receipts or keep detailed books, start now. Keep all receipts or purchase receipts and record all costs in a cash disbursement book or accounting book. Record every expense in detail including:
- Payment amount
- Payment date
- Reason for spending money
- Are payments routine? (Do you have to pay the same fee again?)
Step 2. Separate fixed costs from variable costs or direct costs
The amount of fixed costs does not change regardless of the number of units produced. If you own a postcard factory, the fixed costs you pay each month are the same whether the company produces 100 or 100,000 postcards. The amount of variable costs will change according to the number of production units. The calculations discussed in this article use the postcard factory business as an example. If grouped, postcard manufacturers must issue:
- Fixed cost which consists of machine prices, factory building rental/mortgage costs, insurance, taxes, machine maintenance costs, and salaries of administrative employees.
- Variable Cost which consists of the use of paper, ink, the cost of shipping goods to the buyer.
Step 3. Find out which fixed costs are often overlooked
Open the financial records to find out what expenses have been paid monthly or annually. Fixed costs play an important role for business continuity and the amount will increase if the business grows or vice versa. As long as business conditions are stable, The amount of fixed costs will not change because it is not affected by the number of products produced or sold. Be aware that there are costs that fall into the categories of fixed costs and variable costs. For example:
- Labor costs. If postcard production increases, you may need to add employees, but administrative, bookkeeping, etc. not added, unless the company is enlarged.
-
Licensing fees, taxes, etc.
As your business grows, taxes and licensing fees will increase, but for the use of equipment, buildings, or other facilities, you will have to pay a certain amount of licensing fees and taxes every month or every year.
- Maintenance and repair costs. The factory can operate for 6 months without having to make repairs, but the entire office building suddenly has to be renovated. The cost of building repairs doesn't seem like a fixed cost, but all companies must carry out maintenance and repairs. Open the financial records for the past period or calculate the average repair costs over the last 12 months. After careful scrutiny, it can be concluded that maintenance and repair costs are fixed costs.
Step 4. Divide the fixed costs by the number of units of production
This simple calculation is an important step to determine the selling price and determine how to develop the business. For example: the postcard company's fixed fee is IDR 100,000/month. If you produce 200 cards in a month, each card will be charged a flat fee of IDR 500/sheet. The more cards produced, the lower the fixed cost per sheet and the higher the company's profit.
These costs are called “Fixed Costs per Unit”
Step 5. Recognize that increasing units of production will lower fixed costs per unit
Fixed costs are costs that are inevitable and can only be eliminated if the business is stopped. Although fixed costs cannot be reduced, an increase in production units and sales can reduce the impact on the company. For this reason, mass production costs will always be cheaper than making individual products in small quantities. Using the postcard business example:
- The company has to pay a fixed fee of IDR 500,000,000. Making a postcard costs IDR 500 to pay for paper, ink, and labor.
- If the company makes 500,000 postcards, the fixed cost per sheet = $1,000. So, for a postcard, the total fixed costs and variable costs (ink, paper, etc.) = $1,500.
- If the selling price per share is IDR 2,500, you will get a profit of IDR 1,000 / share.
-
However, if you create and sell 1,000,000 postcards, the fixed fee will be IDR 500/sheet bringing the total cost to IDR 1,000/sheet. This way, you get a profit of IDR 1,500/share without changing the selling price or market demand for the postcard.
Keep in mind that in reality, the way to lower fixed costs is not as simple as the example above. A drastic increase in production will increase fixed costs, but variable costs can fall. However, mass production to keep costs distributed is still the best option
Method 2 of 2: Creating a Fixed Cost Budget
Step 1. Calculate fixed costs by estimating depreciation expense, interest expense, and taxes to determine company targets and performance
The simple calculation described in the first method is one way of knowing the distribution of costs and setting up funds. Use the following equation to estimate the amount of fixed costs over a certain period:
Fixed Cost = Machine Price + Depreciation Fee + Loan Interest Fee + Insurance Fee + Tax This formula can be used to find out the amount of fixed costs that must be paid in the future, for example: mortgage payments or factory machine repair costs. Although it may seem complicated, the formula helps you estimate the selling price of the machine in case you want to stop doing business.
To calculate fixed costs with this formula, assume you want to make estimates for the next 10 years, or even more
Step 2. Enter the amount of money spent to buy the machine into the “Machine Price” in the above formula
For example: You buy a postcard printing machine for Rp. 10,000,000. This is called “Machine Price”. Even if you pay for the machine by withdrawing a loan and repaying it for IDR 2,000,000/year, the number used as the “Machine Price” is still IDR 10,000,000.
- Don't forget to add maintenance and repair costs to the "Machine Price". To simplify the calculation, we assume the cost is only IDR 100,000/year. This means, over the next 10 years, you will pay IDR 1,000,000 for maintenance and repair of the machine (10 x IDR 100,000).
- So, Total Fixed Costs for 10 years of ex-machine purchase = Rp11,000,000 + Depreciation Fee + Loan Interest Fee + Insurance + Tax.
Step 3. Calculate depreciation expense by estimating the selling price of the machine
Maybe you need to buy a new machine in 10 years. Even if the existing machine is not for sale, you need to determine the selling price. This method may seem strange, but it will feel natural if we see it as "expending money to maintain ownership of the machine". For example: the market selling price of a printing press in the next 10 years is estimated at IDR 500,000. If the machine is not sold, you will lose Rp9,500,000 which will be received back by selling the machine.
So, Total Fixed Costs for 10 years of ex-machine purchase = Rp11,000,000 + Rp9,500,000 + Loan Interest Fee + Insurance + Tax.
Step 4. Calculate the interest cost of the loan to buy the machine
If the purchase of the machine is made by withdrawing a loan, you have to pay interest every certain period. For example: assuming the loan interest rate is 1%/year, you have to record a prepaid interest expense of IDR 1,000,000 for 10 years (10% x IDR 10,000,000) and then add that number to the cost of the machine.
So, Total Fixed Costs for 10 years of ex-machine purchase = IDR 11,000,000 + IDR 9,500,000 + IDR 1,000,000 + Insurance + Tax.
Step 5. Add up other payments related to the purchase of the machine, for example:
insurance and taxes. For example: you need to insure a new machine against the risk of fire or natural disaster by paying a premium of Rp. 500,000/year and a machine maintenance fee of Rp. 10,000/month (Rp. 120,000/year). In addition, there is still a checking fee of Rp. 100,000/year to ensure the machine remains safe when operating. You must record all these expenses as prepaid expenses for 10 years of IDR 7,200,000 (10 x IDR 720,000) for owning a printing press.
So, Total Fixed Costs for 10 years of ex-machine purchase = IDR 11,000,000 + IDR 9,500,000 + IDR 1,000,000 + IDR 7,200,000.
Step 6. Calculate the “Total Fixed Costs” by adding up all the money spent to find the cost of the machine assuming the machine is not sold for 10 years
This is one of the right ways to find out the long-term impact of investing. In addition to knowing daily costs, the calculation of fixed costs can be used to develop long-term strategies or determine product selling price policies.
The final result, Total Fixed Costs for 10 years of ex-machine purchase = Rp11,000,000 + Rp9,500,000 + Rp1,000,000 + Rp7,200,000 = IDR 28,700,000.
Tips
- Estimating costs slightly higher is considered the safest way to budget expenditures. Excess funds due to budget costs greater than actual can be allocated as long-term savings.
- If you are having trouble determining the amount of fixed costs (for example, because the business is just starting out), search the internet for information and use the financial statements of the same business.
