Variable and Fixed Expenses: Understanding the Differences

Effectively managing expenses in business is akin to walking a tightrope. While spending is necessary for growth, meticulous planning around both fixed and variable expenses is essential to safeguard profitability and prepare for unforeseen challenges. By grasping the nuances between — and impacts of — these two types of expenses, businesses can better strategise their financial management. In this article, we will delve into the disparities between fixed and variable expenses, their impacts on cash flow, and offer actionable strategies to fortify your financial standing and future-proof your business.

Understanding the Basics: Fixed Versus Variable Expenses

Let’s start by defining fixed expenses and variable expenses.

 

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What is a Fixed Expense?

Fixed expenses remain consistent month after month, regardless of the amount of goods produced or hours worked. These costs are typically predetermined through contracts or agreements, with minimal fluctuation over time. While there may be price adjustments during the term of the agreement, these are known costs.

Examples of Fixed Expenses

• Rent payments
• Vehicle leases
• Insurance
• Interest payments
• Internet service
• Salaried employees

What Is a Variable Expense?

Variable expenses are contingent on various factors, notably the volume of goods produced or services rendered. As production increases, so do expenses related to utilities, labour, and other variable costs.

Examples of Variable Expenses

• Raw material costs
• Labour
• Utility expenses
• Sales commissions
• Business travel
• Freight and shipping

Impact on Cash Flow Management

There’s a direct correlation between fixed vs variable expenses and cash flow. The more expenses you have, the more revenue you have to generate to be profitable. The interplay between fixed and variable expenses significantly influences cash flow dynamics. Balancing these expenses is critical to ensuring sustained profitability and operational continuity.

You must have enough cash coming into your business to pay operating expenses and keep the business running or make future investments to grow the business. While fixed expenses yield a predictable baseline for budgeting, variable expenses fluctuate with activity. For example, a significant purchase order might strain cash flow to purchase the raw materials needed to produce the goods.

Both impact cash flow dynamics in different ways.

Stability Versus Flexibility

Fixed expenses offer stability by providing a predictable baseline for budgeting. However, they often lack flexibility due to contractual obligations and may present challenges in adapting to changing circumstances, such as contractual stipulations that limit your ability to terminate the expense.

Variable expenses, while less predictable, offer greater flexibility. Businesses can adjust these expenses based on fluctuating demand or market conditions, allowing for agile responses to evolving circumstances. For example, you can delay investments in new equipment or inventory as business slows.

Planning and Forecasting

Managing fixed expenses requires meticulous planning to ensure you have sufficient cash flow to cover ongoing operational costs.

Variable expenses require accurate forecasting to prevent overspending or underspending.  Maintaining optimal inventory levels is crucial to meeting customer demand without tying up excess capital that could be used elsewhere.

Decision-Making

Both fixed and variable expenses influence strategic cash flow management and decision-making. While reducing expenses can alleviate financial strain, investments in areas like marketing and sales may be necessary to drive revenue growth.

Examples of Expense Management Strategies

Several strategies can help businesses optimise cash flow by managing fixed and variable expenses effectively. A few examples include:

• Reducing fixed costs by transitioning to a shared office space.
• Renegotiating contracts at renewal to lower costs or shifting to an alternate provider.
• Negotiating with suppliers for extended credit and payment terms, allowing more time to collect from customers to cover variable costs.
• Adjusting staffing in seasonal businesses based on seasonal demand fluctuations to minimise excess labour during off-seasons.
• Employing AI and automation to detect and prevent expense fraud.

Future-Proofing Financial Strategies

Unexpected changes are inevitable, so businesses need to build agility and adaptability into their financial strategies to protect against downsides and act swiftly when opportunities arise. Some financial strategies to help future-proof your business include:

Employing Strong Expense Controls

Establishing a robust budgeting process allows you to monitor and track spending, while continuously looking for ways to reduce costs can help maximise profits. Clear expense policies must be put in place. The right expense management platform can help you ensure spend aligns with company policies and reduce expense fraud.

Leveraging Data

Tracking and analysing historical financial data enables you to uncover trends in expenses and cash flow. Combining data analytics with forecasting and modelling tools gives you the insights you need to track spending patterns, identify trends, and make informed decisions about resource allocation.

Essential indicators, such as cash flow, margins and debt ratio, should be monitored in real-time, providing snapshots of financial health and risk.

Improving Flexibility

Businesses can also negotiate flexibility in contracts. Entering into agreements with shorter commitment periods or variable cost structures can help you adapt to changes more easily. For example, with SaaS software, you can often pay for what you currently need with the option to scale costs as users grow.

Smart business leaders also develop contingency plans. While you can’t predict everything that will happen in the future, you can have a plan for managing expenses in light of falling consumer demand, economic downturns, or supply chain disruptions.

Building Resilience

Companies need to manage cash flow smartly as well. Building a cushion of liquid or near-liquid funds can help handle unexpected expenses without having to cut back on other areas. You can also build resilience by lowering your debt burden to free up cash flow for future investments, while reducing exposure to rising interest rates.

Companies will additionally benefit from building stronger relationships with key lenders, suppliers, and customers. This can give you negotiating power to secure more favourable terms, especially in challenging economic times.

Seeking Continuous Improvement

The companies best positioned to grow are those investing in their workforce and embracing new technologies. Experimenting with innovative financial and operational models — and always looking for opportunities to improve — helps keep your team aligned with emerging industry trends.

As the saying goes: the only constant is change. Business leaders must embrace a growth mindset and continually adapt and innovate to remain competitive.

Controlling Costs and Cash Flow

Effectively managing both fixed and variable expenses is foundational to sound financial management. By implementing tailored strategies to control costs and optimise cash flow, businesses can enhance their financial resilience and position themselves for sustained growth.

SAP Concur is a cloud-based expense management solution that can help businesses automate, accelerate, and improve expense management.

SAP Concur solutions provide businesses with tools to track expenses accurately and promptly, ensuring leaders have the spend visibility they need to make critical, real-time decisions about finances, budgets, and strategic priorities.

To learn more about controlling expenses and managing cash flow, explore SAP Concur's comprehensive guide: Control Company Costs and Cash Flow.