To help students better understand account principles, they are often introduced to costs as being fixed or variable. In reality, many of the costs that businesses incur fall in the middle; in essence they are mixed costs.
Variable costs are the type that increase or decrease depending of the level of activity being undertaken. For example a drink company normally will not spend money for juice concentrate if it isn’t making drink products, but can expect the sum that it pays to its suppliers to rise in direct proportion to the amount of drinks it makes. Therefore, management will not need to worry about incurring variable costs if operations are temporarily shut down.
On the other hand, fixed costs remain constant with little regard to the level of production being realized. A good example of fixed costs is rent. Of course there are exceptions, but whether or not a company is using the full capacity of the facility it is renting, the rent will still become due. However, a positive characteristic of fixed costs is that they usually remain constant; and so everything that is earned after the break-even point is reached increases profit margin.
It is important to note that fixed costs aren’t always fixed. In fact, they only stay constant within a production or activity range. For example, the cost of renting a space that can hold enough machinery to produce 100K units max will move upward if production capacity needs to be increased to 200k.