Electricity Cost – Fixed Cost Or Variable Cost?

What is a Fixed Cost?

Fixed costs are expenses that a business must take on regardless of the level of production. This type of cost does not change with production levels and can include direct or indirect expenses that can affect profitability at different points on the income statement.

Fixed costs are used to calculate key metrics such as breakeven analysis and a company’s operating leverage.

In terms of electricity cost, it can be considered a fixed cost depending on the company’s electricity plan. If the company has a flat rate plan, the cost will remain the same regardless of the amount of electricity used. However, if the company has a variable rate plan, the cost of electricity will fluctuate with the amount of electricity used.

What is a Variable Cost?

Variable costs are expenses that vary in proportion to production output or sales. This means that when production or sales increase, variable costs increase, and when production or sales decrease, variable costs decrease.

Variable costs are important to consider when calculating a product’s contribution margin, which is used to determine a company’s break-even or target profit level.

The following points highlight the significance of variable costs:

• Variable costs change in proportion to production output or sales
• When production or sales increase, variable costs increase
• When production or sales decrease, variable costs decrease
• Variable costs are important in calculating a product’s contribution margin

Is Electricity Variable Costs?

Electricity consumption can be classified as either a fixed or variable cost, depending on the source.

Generally, electricity related to production will be classified as variable cost because it is impacted by the number of production units as well as the amount of time taken to produce them.

However, electricity costs related to administrative tasks, such as those in the head office, are not impacted by production and are therefore classified as fixed costs.

Fixed costs are the same regardless of production volume and are the same each month, while variable costs fluctuate with production.

Advantages of a Fixed Cost

Having a predetermined amount of overhead costs provides businesses with a reliable way of managing their budget and allows them to make informed decisions.

Fixed costs provide stability to the business by not changing until a specified period. This allows businesses to accurately forecast their expenses and plan accordingly.

Fixed costs allow businesses to easily budget and plan for their expenses, providing them with an accurate prediction of their costs. This eliminates the need for last-minute adjustments and can help ensure that the business can remain profitable.

Additionally, fixed costs can help businesses take advantage of any potential savings due to reduced rates or promotional offers. By having a fixed cost, businesses can leverage these opportunities to their advantage.

Disadvantages of a Fixed Cost

Despite the potential savings from fixed costs, businesses may be limited in their ability to take advantage of promotional offers or discounts due to the predetermined amount of overhead.

This can lead to a decrease in profits if businesses are unable to take advantage of such discounts, which would be especially detrimental for businesses with high overhead costs.

Additionally, if a business experiences a decrease in sales due to economic downturns or other events, their fixed costs will remain the same, potentially leading to an increase in costs relative to their income.

This could result in a situation in which businesses are unable to cover their fixed costs, leading to a further decrease in profits.

Advantages of a Variable Cost

The transition from the previous subtopic, which discussed the disadvantages of a fixed cost, to this current subtopic, which will discuss the advantages of a variable cost, is one of cost flexibility. Variable costs provide more flexibility than fixed costs, allowing businesses to be more responsive to changes in the marketplace.

A key advantage of a variable cost, such as electricity costs, is that it allows businesses to easily scale their operations up or down to respond to changing demand.

Variable costs are also more predictable than fixed costs, allowing businesses to plan their operations more accurately.

Additionally, variable costs are often more affordable than fixed costs, providing businesses with greater cost savings.

Finally, variable costs are often more flexible, allowing businesses to make changes to their operations without long-term commitments or contracts.

Disadvantages of a Variable Cost

Though offering greater flexibility and predictability than fixed costs, variable costs can also have some drawbacks.

The main disadvantage of variable costing is that it does not take into account fixed costs when calculating product costs.

This can lead to sub-optimal decision-making by managers, which in turn can result in:

• Higher inventory levels than necessary
• Increased costs associated with storage
• Lower profits due to overproduction
• Inability to take advantage of economies of scale

Conclusion

Electricity is a form of energy that is used by households and businesses alike. It is an essential component of modern life and is usually subject to cost.

Depending on the pricing structure, electricity can be either a fixed or variable cost. Fixed costs are those that remain relatively constant over a given time period regardless of usage. Variable costs are those that fluctuate with usage.

Although both fixed and variable costs have advantages and disadvantages, it is important to consider both when deciding which type of cost structure is best for a particular situation. Ultimately, the best choice will depend on the individual needs of the customer and the thorough analysis of the costs associated with each.