A quiet Tuesday at Mill Lane: On a normal night the Mill Lane bakehouse bakes about 1,200 loaves for the three shops. One wet Tuesday in February the shops order only 900.
Bills that did not change
- Priti and her six bakers still work the whole shift from 2 a.m.
- The rent on the three shops is still due.
- The vans are still insured.
- Aisha, Kofi and Jonas are still paid their salaries.
None of those bills noticed that 300 fewer loaves were baked.
A cost that stays the same however much the business makes or sells is a fixed cost. Fixed costs do not change when output changes. Bake 900 loaves or 1,500, and the week's fixed costs are the same.
Lena's Bakery's fixed costs
Salaries and shift wages
The shop managers are paid a salary, and the bakers are paid for the night shift, whether the ovens are full or half-empty.
Rent
The rent on the High Street, Market Square and Park Road shops is set in the lease, month by month, not loaf by loaf.
Insurance
The vans and the buildings are insured for a fixed sum a year.
Advertising
An advert in the local paper costs the same whether it brings in ten customers or a hundred.
Fixed does not mean it never changes: Fixed means the cost does not change when output changes. It can still change for other reasons: if the landlord raises the rent on Park Road, fixed costs rise, though not one extra loaf is baked.
Some fixed costs are paid only once: The sign and the licence for Lena's first shop (3.1.1) were start-up costs: paid in the first year and never again, so the next year's fixed costs were lower.
A quick check: if the bakehouse baked nothing at all for a week, which bills would still arrive? Those are the fixed costs. On the quiet Tuesday, the fixed costs stayed exactly where they were. Each loaf carried a bigger share of them, but the total did not move.
An oven is not a fixed cost: The $45,000 deck oven Lena plans for Mill Lane is capital expenditure (3.1.2): it buys an asset the bakery will own for years. Land, buildings, ovens and vans are fixed assets, not fixed costs.
The fixed costs are the bills that come with them: the rent on the shops, the insurance on the building and the vans.
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Every loaf that leaves Mill Lane takes flour from Valley Grain, yeast, salt and a paper bag with it: about $0.90 of ingredients and packaging a loaf.
| Loaves baked | Ingredients and packaging |
|---|---|
| 1,200 | $1,080 |
| 900, on the quiet Tuesday | $810 |
| Nothing | Nothing |
Variable costs: A variable cost changes when output changes. It rises when the business makes more, falls when it makes less, and is zero when it makes nothing.
The cost for one unit stays the same: $0.90 a loaf. The total grows with every loaf.
| Loaves baked in a night | Ingredients and bags at $0.90 a loaf |
|---|---|
| 0 | $0 |
| 900 (the quiet Tuesday) | $810 |
| 1,200 (a normal night) | $1,080 |
| 1,500 (the week before a holiday) | $1,350 |
So the total is one multiplication: Variable costs = variable cost per unit × output. At 1,200 loaves, $0.90 × 1,200 = $1,080.
Fixed at Lena's
- Rent on the three shops
- Salaries of Aisha, Kofi and Jonas
- Insurance on the vans and buildings
- Advertising in the local paper
Variable at Lena's
- Flour from Valley Grain
- Butter, yeast, fillings and other ingredients
- Paper bags and cake boxes
- A fee on every card payment at the counter
Wages can be either
- A salary or a set shift is fixed: paid whatever is baked
- Pay for each extra batch, or per item made, is variable
- Commission on each sale is variable
Some bills have a bit of both: The electricity bill has a standing charge that is paid every month, plus a charge for each unit used. A bill like that is sometimes called a semi-variable cost.
Electricity at Lena's: At Lena's the ovens burn for the whole shift, full or not, so the bakery counts its electricity with the fixed costs.
In a question: Sort each cost by its main part and say why: does it change when output changes?
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Add the two kinds together and you have everything it costs to run the business at that level of output.
Total cost = fixed costs + variable costs. Here is one week at Lena's Bakery Ltd, using the week of bills from 3.1.1.
Worked example: one week's total cost
Step 1: sort the bills
Wages $14,400, rent and electricity $3,500, and van fuel, repairs and insurance $2,000 do not change with the number of loaves: fixed. Flour and ingredients, $9,200, do: variable.
Step 2: add the fixed costs
Fixed costs = $14,400 + $3,500 + $2,000 = $19,900 a week.
Step 3: take the variable costs
Variable costs = $9,200 a week: the flour from Valley Grain and everything else that goes into the bread, cakes and lunches.
Step 4: add the two
Total cost = fixed costs + variable costs = $19,900 + $9,200 = $29,100 a week.
The whole of 2025 sorts the same way. Fixed costs were $1,035,000: wages and salaries $750,000, rent and utilities $180,000, other running costs $105,000. Variable costs, the ingredients and packaging, were $480,000. Total cost = $1,035,000 + $480,000 = $1,515,000.
The formula in one line: Total cost = fixed costs + (variable cost per unit × output)
Write the formula, put in the numbers, then give the answer with its $ sign. A slip in one step then costs one step, not the whole answer.
Now a hotel asks for 1,000 more loaves a week. The bakers already on shift can bake them, so the fixed costs do not move. Only the variable costs grow: 1,000 × $0.90 = $900.
| A normal week | With the hotel order | What changed | |
|---|---|---|---|
| Fixed costs | $19,900 | $19,900 | Nothing: no new rent, no new salaries |
| Variable costs | $9,200 | $10,100 | + 1,000 loaves × $0.90 = $900 |
| Total cost | $29,100 | $30,000 | Up by the extra variable costs only |
Two slips with total cost: Forgetting the fixed costs. $9,200 is the variable cost, not the total. The rent and wages are part of what the week cost.
Counting fixed costs again. More output does not bring a second rent bill. Only the variable costs grow with the order.
What does Park Road cost to run?: Lena asks Jonas a simple question: how much did the Park Road shop cost last month? Some bills belong to Park Road alone. Others have no single home.
| Bills that belong to Park Road alone | Bills shared by all three shops and the bakehouse |
|---|---|
| Its rent | The vans |
| Jonas's salary | The accountant |
| The wages of his three counter staff | Lena's own salary as managing director |
A direct cost can be traced to one cost object. An indirect cost, also called an overhead, is shared by several products or departments, so it cannot be traced to any one of them.
Direct costs of a sourdough loaf
- The flour, water and salt in it, weighed out for that loaf.
- The paper bag it goes home in.
- The baker's time mixing, shaping and baking it (direct labour).
Overheads of the whole bakery
- Lena's salary as managing director: she runs everything.
- The accountant's fee for the company's yearly accounts.
- Insurance and advertising for the business as a whole.
- The vans, which carry every product to every shop.
Two different questions: Fixed or variable asks: does the cost change when output changes? Direct or indirect asks: can I trace it to one product or department?
They often line up, but not always. Park Road's rent is fixed, yet it is a direct cost of the Park Road shop.
| Cost | Changes with output? | Traced to one product or shop? |
|---|---|---|
| Flour for the sourdough | Yes: variable | Yes: direct cost of the sourdough |
| Paper bags | Yes: variable | Yes: one per loaf, direct |
| Park Road's rent | No: fixed | Yes: direct cost of the Park Road shop |
| Jonas's salary | No: fixed | Yes: direct cost of the Park Road shop |
| Lena's salary | No: fixed | No: an overhead shared by the whole bakery |
| Insurance on the vans | No: fixed | No: an overhead shared by all three shops |
When a case gives a "direct cost per unit", it means the materials and labour that go into each unit. It rises with every unit made, so it is used just like a variable cost per unit. Overheads still have to be paid by someone: every shop's sales help to cover them.
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How this comes up: Fixed costs come up in short questions of two marks each, either at the start of a case or with a table of costs.
The four usual questions
- Define the term fixed cost, for two marks.
- State two examples of fixed costs, for two.
- Comment, with a table of costs, on what happens to fixed costs if output falls, for two.
- Explain, for a business that has just started, one reason why its fixed costs are likely to fall next year, for two.
The pattern for each
- Define fixed cost. Costs that do not change when output changes. Two ideas: they stay the same, and it is output they do not change with.
- State two examples. Rent, salaries, insurance, advertising. A few words each.
- Comment on fixed costs when output falls. They stay the same, and say the figure from the table.
- Explain why fixed costs will fall. Some were one-off start-up costs, then name them from the case: the website, the launch advertising.
Three traps: An example is not a definition. 'Rent' does not say what a fixed cost is.
A fixed asset is not a fixed cost. Land, buildings, machinery and vans are things the business owns. Rent, insurance and salaries are the costs.
Fixed costs do not fall when output falls. The share each unit carries rises, but the total stays the same.
Using the table, comment on the effect on Lena's Bakery Ltd's fixed costs if the number of loaves baked in a week decreases from 8,400 to 7,000.
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