Fixed Versus Variable Expenses – What is the difference?

It may sound like a simple concept at first, but classifying expenses as fixed and variable in the context of a business interruption claim can be tricky.  The issue that often trips people up is thinking in absolutes, such as, how would the expense behave in the event the business is shut-down?  But, this is not the way to look at this issue.

When we talk about identifying fixed and variable expenses for the purposes of a BI claim, what we are talking about is, how does the expense behave during the normal operation of the business.  Fixed expenses are those costs which do not change within a reasonable range of sales.  The easiest example of a fixed expense is rent.  Whether a business has sales of $10,000 or $20,000 per month, the amount of rent they pay for the space is likely the same.

On the other hand, variable expenses are those which vary directly with sales.  The most common example of this is the cost of whatever product it is the business is selling.  For example, the largest variable expense in a clothing store would be the cost of the clothing they sell.

Other expenses can fall into a bit of a grey area and whether they are fixed, or variable will depend on the nature of the business.  For example, in a manufacturing business which consumes a lot of water and power to operate, the utilities cost is likely variable, but for a convenience store which uses the same amount of heat and light regardless of sales levels, utilities would be a fixed expense.

The behaviour of an expense after a loss has occurred should not play any role in how it is classified.  In extreme circumstances the behaviour of even the most consistent fixed expense is likely to change.

Some examples of common fixed and variable expenses may include (not an exhaustive or definitive list):