Fixed operating costs represent any cash outflows for business necessities that do not change over time. In most cases, all businesses have some type of fixed costs in their operations. Most of the costs relate to the company’s facilities, personnel, and equipment. In accounting, fixed operating costs can lead to a concept known as operating leverage. Operating leverage is a mix between a company’s fixed and variable costs, with higher fixed costs more likely to create riskier situations.
A company’s facilities contain any number of fixed operating costs depending on the size and scope of the facilities. Common fixed costs include rent, lease payments, depreciation, and property taxes. Most of these fixed costs remain the same the entire time a business stays in operation. The costs can, however, move up or down at different points in time; for example, when a lease runs out, the company may renew the lease but at a higher cost. Increased property taxes can also be a moving fixed cost when governments change tax rates.
Personnel can also represent a large portion of a company’s fixed operating costs. The fixed costs here arise from a company’s salaried employees. Most salaried employees include a company’s management team and other administrative salaried staff. Accountants often separate the salaries into different classifications, with each one relating to a specific division in the company. This allows accountants to assess each department in terms of unavoidable employee compensation.
Equipment is most common in large manufacturing firms, though other equipment types may be found in all businesses. Fixed operating costs here include payments for the equipment, depreciation, and maintenance contracts. All costs here typically go into an allocation pool for the goods or services produced by the business. Though the costs do not change, they may not continue in perpetuity either. For example, a company will depreciate its equipment only until it reaches the salvage value; then, the costs go away.
Many companies use outside funds to procure and install assets that relate to their facilities and equipment. These loans create higher risk in a business because the payments must always go to the vendor or supplier regardless of operating activity. In economic contractions, a company can experience financial hardship due to copious fixed operating costs and low capital. Outside investors tend to find this practice unfavorable at times. Only those companies with a strong mix of fixed and variable operating costs can prove healthy during difficult economic times.