What Are Fixed Costs?

Fixed costs are business expenses that remain constant regardless of the volume of goods produced or services delivered, within a relevant range of activity. Whether a factory produces 1,000 units or 10,000 units in a month, the rent stays the same. Fixed costs must be paid even if the business generates no turnover at all.

Together with variable costs , fixed costs determine the total cost structure of a business and are fundamental to break-even analysis , budgeting , and pricing decisions.

Examples of Fixed Costs

Fixed Cost	Typical Annual Amount (Small UK Business)
Rent and business rates	£12,000 - £60,000
Building insurance	£1,000 - £5,000
Employer’s liability insurance	£500 - £3,000
Salaried staff (management, admin)	£30,000 - £150,000
Depreciation of fixed assets	£5,000 - £30,000
Software licences (fixed fee)	£2,000 - £10,000
Accounting and audit fees	£2,000 - £15,000
Telephone line rental	£500 - £2,000
Loan repayments (interest element)	Variable by borrowing

Fixed Costs Versus Variable Costs

Feature	Fixed Costs	Variable Costs
Total cost behaviour	Constant within range	Changes with output
Per-unit cost	Decreases as output rises	Roughly constant
Risk	Must be covered regardless of sales	Reduce if sales fall
Management focus	Capacity utilisation	Efficiency, purchasing
Examples	Rent, insurance, salaries	Materials, commission, freight

Per-Unit Fixed Cost

Although total fixed costs stay the same, the fixed cost per unit falls as output increases. This is the basis of economies of scale:

Output (units)	Total Fixed Costs (£)	Fixed Cost Per Unit (£)
1,000	100,000	100.00
5,000	100,000	20.00
10,000	100,000	10.00
20,000	100,000	5.00

At higher volumes, each unit bears a smaller share of fixed costs, improving profitability per unit.

Stepped Fixed Costs

In practice, fixed costs are only constant within a relevant range. Beyond certain thresholds, they increase in steps:

Output Range	Warehouse Rent (£)	Reason
0 - 15,000 units	30,000	One warehouse
15,001 - 30,000 units	60,000	Second warehouse needed
30,001 - 50,000 units	90,000	Third warehouse needed

When planning expansion, stepped fixed costs must be built into budgets and break-even calculations.

Committed Versus Discretionary Fixed Costs

Type	Description	Examples
Committed	Contractual or structural costs that cannot be avoided in the short term	Rent, loan interest, insurance
Discretionary	Costs set by management decision that can be adjusted	Training, marketing, R&D, charitable donations

During a downturn, discretionary fixed costs can be cut quickly. Committed costs require renegotiation, contract expiry, or structural change to reduce.

Fixed Costs and Break-Even Analysis

Fixed costs are the numerator in the break-even formula:

Break-Even Point (units) = Fixed Costs / Contribution Per Unit

Where contribution per unit = selling price - variable cost per unit.

Impact of Fixed Cost Changes on Break-Even

Fixed Costs (£)	Contribution Per Unit (£)	Break-Even (units)
80,000	20	4,000
100,000	20	5,000
120,000	20	6,000
150,000	20	7,500

Every increase in fixed costs raises the break-even point and the level of risk. This is why businesses should carefully evaluate any decision that permanently increases fixed costs.

Operating Leverage

Operating leverage measures the proportion of fixed costs in the total cost structure. A business with high fixed costs and low variable costs has high operating leverage.

Degree of Operating Leverage = Contribution / Operating Profit

Company	Contribution (£)	Fixed Costs (£)	Operating Profit (£)	DOL
High leverage	300,000	250,000	50,000	6.0
Low leverage	150,000	100,000	50,000	3.0

A DOL of 6.0 means a 10% increase in sales produces a 60% increase in operating profit – but a 10% decline in sales produces a 60% fall in profit. High operating leverage amplifies both gains and losses.

Implications for UK Businesses

High leverage suits businesses confident in stable or growing demand (software companies, subscription businesses)
Low leverage is safer for businesses with volatile demand (seasonal retailers, project-based contractors)
Converting fixed costs to variable (e.g., outsourcing, pay-per-use contracts) reduces leverage and risk

Fixed Costs on the Income Statement

Under the Companies Act 2006 Format 1 (analysis by function), fixed costs are spread across:

Category	Fixed Cost Examples
Cost of sales	Factory rent, production supervisor salaries, equipment depreciation
Distribution costs	Warehouse rent, delivery vehicle insurance
Administrative expenses	Office rent, management salaries, insurance

For internal management accounting purposes, a marginal costing format separates fixed from variable:

Line	£
Turnover	500,000
Variable costs	(200,000)
Contribution	300,000
Fixed costs	(250,000)
Operating profit	50,000

Fixed Costs and Cash Flow

Fixed costs represent a baseline cash requirement that must be funded every month. When preparing a cash flow forecast:

Non-cash fixed costs (depreciation, amortisation) reduce profit but do not consume cash
Prepaid fixed costs (annual insurance paid upfront) create a cash outflow in one month but are spread across the year in the income statement
Accrued fixed costs (utility bills received after the period) appear in the income statement before the cash payment

Businesses with high fixed costs need strong cash reserves or credit facilities to survive periods of low revenue.

Reducing Fixed Costs

Strategy	Example
Downsize premises	Move to a smaller office or negotiate reduced rent
Flexible staffing	Use contractors instead of permanent employees
Technology substitution	Replace expensive on-premises IT with cloud services
Outsource functions	Payroll, IT support, cleaning
Renegotiate contracts	Insurance, telecoms, maintenance agreements
Share resources	Co-working spaces, shared warehousing

Every reduction in fixed costs directly lowers the break-even point and improves the margin of safety.

Fixed Costs and Corporation Tax

Fixed costs are generally tax-deductible for corporation tax provided they are incurred wholly and exclusively for the trade. Key exceptions:

Fixed Cost	Tax Treatment
Depreciation	Not deductible (replaced by capital allowances)
Business rates	Deductible
Rent	Deductible
Insurance	Deductible
Client entertaining	Not deductible
Fines and penalties	Not deductible

Depreciation is the most significant difference. The accounting charge is added back and replaced with capital allowances (Annual Investment Allowance, writing-down allowances) which follow HMRC’s rules rather than the company’s depreciation policy.

Fixed Costs and Budgeting

Fixed costs are the most predictable element of a budget because they do not change with activity levels (within the relevant range). This makes them the foundation of the expenditure budget:

List all committed fixed costs – these form the non-negotiable baseline
Add discretionary fixed costs – training, marketing, and other planned spending
Identify stepped costs – additional fixed costs triggered by growth beyond current capacity
Stress test – what happens to profitability if turnover falls 10%, 20%, or 30% while fixed costs remain unchanged?

The higher the proportion of fixed costs, the more important it is to build pessimistic scenarios into the budget.

Fixed Costs in Different Business Models

Business Model	Fixed Cost Level	Variable Cost Level	Operating Leverage
Software / SaaS	Very high	Very low	Very high
Professional services	High	Moderate	Moderate-high
Manufacturing	High	High	Moderate
Retail (physical)	Moderate-high	High	Moderate
E-commerce (drop-shipping)	Low	High	Low
Freelance / sole trader	Low	Moderate	Low

The business model fundamentally shapes the risk profile. A SaaS company with £500,000 in fixed costs and a 90% contribution margin is highly profitable at scale but extremely vulnerable in the early stages before reaching break-even.