How do fixed costs differ from variable costs?

Fixed costs are expenditures that do not change with the level of production or sales activity within a specific range. This means that regardless of how much a company produces, these costs remain stable; examples include rent, salaries of permanent employees, and insurance. On the other hand, variable costs fluctuate based on the volume of goods or services produced. For instance, costs for raw materials, hourly wages, and utilities may increase as production ramps up but will decrease when production decreases.

The distinction is essential because it impacts budgeting, financial forecasting, and decision-making for businesses. Understanding these cost dynamics allows finance officers to manage cash flow effectively and assess the breakeven point for new projects or products. So, the correct identification of the differences between fixed costs and variable costs is crucial for sound financial management.