Fixed costs stay the same whatever you produce, such as rent, insurance and permanent staff salaries; variable costs rise and fall with how much you make or sell, such as raw materials and direct labour. Knowing which is which tells you whether closing would cost you more than carrying on.
Corporate Finance Institute (CFI) puts it simply: fixed costs don't change with increases or decreases in production volume, and variable costs do. Its worked bakery example, below, shows why that split is more than bookkeeping.
Fixed vs variable costs at a glance
| Fixed cost | Variable cost | |
|---|---|---|
| Definition | Doesn't change with production volume | Changes with production volume |
| When production rises | The total stays the same | The total rises |
| When production falls | The total stays the same | The total falls |
| CFI's examples | Rent, advertising, insurance, depreciation, interest payments, permanent staff salaries | Direct materials, direct labour, fuel, transaction fees, commissions, utility costs, billable labour |
CFI notes that variable costs are also called direct costs. To total them, it gives a one-line formula: Total Variable Cost = Total Quantity of Output x Variable Cost Per Unit of Output.
The bakery that should stay open
This is CFI's example, and it's the one that makes the idea stick. Amy runs a bakery. In January it took $3,000 in revenue but had $4,000 of costs, a loss of $1,000. She's already committed to a year of rent, electricity and staff salaries. So should she close? Here are her costs, as CFI lists them. They're CFI's US dollar figures, as of October 2026.
| Cost (CFI's bakery) | Type | Amount |
|---|---|---|
| Rent | Fixed | $1,000 |
| Electricity | Fixed | $200 |
| Salaries | Fixed | $500 |
| Ingredients | Variable | $1,800 |
| Labour | Variable | $500 |
| Total fixed | $1,700 | |
| Total variable | $2,300 |
If Amy shuts down, she still pays the $1,700 of fixed costs she's committed to. If she keeps going, she loses $1,000 a month. Closing would cost her $1,700 a month; carrying on costs her $1,000. CFI's advice is to keep trading while looking for ways to bring the variable costs down, for example by finding cheaper raw materials.
Without the split, the obvious answer, to stop the loss, would have been the more expensive one. That's the catch, and it's why I'd sort every cost before making any big call.
Break-even in one line
The same split gives you your break-even point. CFI's formula is: Break-Even Point in Units = Fixed Costs / (Sales Price Per Unit - Variable Cost Per Unit). Amy's cakes cost $5 in raw materials and $20 in direct labour, so $25 each, and sell at $30. With $1,700 of fixed costs, that's $1,700 divided by $5, or 340 cakes a month. I've written a fuller guide to working out your break-even point with more examples, so I'll leave it there.
The variable cost ratio
CFI also describes the variable cost ratio: your variable production costs as a percentage of net sales. You calculate it by dividing variable costs by net revenue, where net revenue is total sales minus returns, allowances and discounts. It's a quick way to see how much of each sale goes straight back out on making the next one.
Sort your own costs in five steps
- List every cost for a normal month.
- Mark each one fixed or variable: would it change if you made or sold more?
- Total each group. In CFI's bakery, that's $1,700 fixed and $2,300 variable.
- Work out your price minus the variable cost per unit.
- Divide your fixed costs by that gap to get your break-even units.
There's a third kind of cost worth knowing about. CFI describes sunk costs as costs a company can't recover even if it goes out of business, such as advertising spend or specialist machines with no scrap value. They follow their own logic, and sunk costs explained covers them in full.
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The one split worth doing this week
Know which bills stop if you stop. That one split tells you whether to push on, cut back or close, and as Amy's bakery shows, the gut answer can be the wrong one. Do it once for your own business with a normal month's numbers. It takes an hour, and you'll make your next big decision on facts rather than nerves.
Frequently asked questions
What is the difference between fixed and variable costs?
Fixed costs don't change with production volume, such as rent and insurance. Variable costs rise and fall with volume, such as raw materials and direct labour.
What are examples of fixed costs?
CFI lists rent, advertising, insurance, depreciation, interest payments and the salaries of permanent staff.
What are examples of variable costs?
CFI lists direct materials, direct labour, transaction fees, commissions, utility costs, fuel and billable labour.
How do you calculate total variable cost?
Multiply the total quantity of output by the variable cost per unit of output.
How do fixed and variable costs give you break-even?
Divide fixed costs by the sales price per unit minus the variable cost per unit. CFI's bakery needs 340 cakes a month to break even.
