What is the main difference between fixed costs and variable costs?

The main difference between fixed costs and variable costs is that fixed costs do not change with production levels, while variable costs do. Fixed costs are expenses that remain constant regardless of the output level, such as rent, salaries of permanent staff, and insurance. These costs must be paid whether a company produces a high volume of goods or none at all.

On the other hand, variable costs fluctuate in direct proportion to the level of production. These include costs like raw materials and labor that are incurred directly in relation to the quantity produced. As production increases, variable costs increase, and if production decreases, variable costs decrease as well.

Understanding this distinction is crucial for businesses when forecasting expenses and making budgeting decisions. For instance, a company with high fixed costs may need to maintain a certain level of production to cover these costs, while a firm with mainly variable costs can be more flexible in adjusting operations based on demand.