finance
Fixed Costs
Costs that don't change with sales volume. The base load you pay every month regardless.
Definition
Fixed costs are expenses that stay the same whether you sell $50K or $500K in a month: rent, salaried payroll, software subscriptions, insurance, depreciation. The opposite of variable costs (which scale with output). High fixed costs create operating leverage - extra revenue drops mostly to the bottom line - but they also create risk in downturns. Service businesses are typically 60-80% fixed cost (mostly payroll), which is why headcount discipline is so critical.
What counts as fixed in US small business
Fixed costs are expenses that do not vary with revenue volume in the short term (typically 12 months). Common categories. Salaried payroll (W-2 employees regardless of utilization). Office or coworking rent. Insurance premiums (general liability, errors and omissions, workers comp, health benefits). Software subscriptions on annual or fixed-monthly plans. Professional fees (accountant, attorney on retainer). Depreciation on equipment. Utility base fees. The test: if revenue dropped 50 percent tomorrow, would this expense still hit the bank? If yes, it is fixed. The fixed-cost base is the floor of your monthly burn.
Operating leverage and the fixed-cost dilemma
High fixed costs create operating leverage: revenue above break-even drops mostly to the bottom line because variable costs are small. A US service business at 60 percent gross margin with high fixed costs sees 60 cents of every incremental revenue dollar reach EBIT. The flip side: revenue below break-even produces sharp losses because fixed costs do not adjust. The choice between fixed and variable cost structure is strategic. SaaS businesses lean fixed (recurring revenue makes the bet safer). Agencies and consulting lean variable (contractor heavy) until they reach scale. Get the fixed-variable mix wrong for your revenue model and the next downturn becomes existential.
Variable-izing fixed costs in service businesses
Three practical levers for converting fixed to variable. One, replace some salaried roles with contractors paid per project. Two, use elastic infrastructure (AWS, Google Cloud) that scales with usage instead of fixed servers. Three, structure marketing budget as variable percentage of revenue rather than fixed monthly spend. Variabilization reduces operating leverage (less upside in growth) but increases resilience (less downside in contraction). Most US service businesses under 2M revenue should lean variable; above 5M revenue, the predictability of recurring revenue justifies more fixed structure.
Auditing fixed costs quarterly
Most fixed-cost lines accumulate unchecked over time. Quarterly audit: list every fixed-cost line, the original justification, the actual usage or value over the last 90 days, and whether it should continue, change, or end. Common findings on first audit: 200 to 500 dollars per month of forgotten SaaS, an underused office lease at 20 percent capacity, insurance policies bundled with unnecessary coverage, professional retainers consuming hours never used. Killing or right-sizing 10 to 20 percent of fixed costs in the first audit is typical. Subsequent audits find 3 to 5 percent. The discipline compounds.
FAQ
Is salaried payroll always fixed?
In the short term yes, but it becomes variable through hiring and firing decisions over 6 to 12 months. The distinction matters because layoffs in the US are practically and legally complex (WARN Act notification requirements, severance norms, unemployment claims), so payroll cannot be cut as quickly as discretionary spend. Treat salaried payroll as fixed for any decision under 12 months horizon. For longer planning, model headcount as semi-variable that adjusts with revenue band.
Should I count health insurance as fixed?
Yes for the employer-paid portion. US employer health insurance contributions are typically structured per enrolled employee per month, so the total scales with headcount but not with revenue. Once employees are enrolled, the monthly premium is a fixed obligation regardless of business volume. Group health plans typically allow open enrollment changes only annually, so even if you reduce headcount, the per-employee premium does not adjust mid-year. Plan accordingly when modeling fixed-cost base.
How fast can fixed costs realistically be cut?
Three tiers. Tier 1 (under 30 days): software subscriptions you can cancel mid-cycle, contractor engagements with short notice clauses, discretionary marketing spend. Typically 5 to 15 percent of fixed costs. Tier 2 (30 to 90 days): annual SaaS contracts ending, professional retainers with notice periods, equipment leases. Typically another 5 to 10 percent. Tier 3 (90 to 180 days): real estate lease, payroll reductions, insurance restructuring. Typically the remaining 10 to 25 percent if needed. Document this cut plan in advance so it can be executed quickly when revenue stress arrives.
What fixed-cost ratio is healthy for a US service business?
Fixed costs typically run 60 to 80 percent of total cost for US service businesses, with payroll being the dominant share (50 to 70 percent of fixed). The remaining 20 to 40 percent is variable (contractors, sales commissions, payment processing). Higher fixed-cost ratio means more operating leverage but more risk. Match the ratio to revenue predictability: high recurring revenue can support higher fixed ratio; project-based or seasonal revenue should keep fixed ratio lower to maintain resilience.
Does depreciation count as fixed cost?
Yes, but as a non-cash fixed cost. Depreciation reflects the spreading of capital expenditure over the asset useful life and shows up as an expense on the P&L without any cash movement. For break-even and operating leverage analysis, include depreciation in fixed costs. For cash flow planning, exclude it because there is no cash outflow associated. The capital expenditure itself was a cash event when the asset was purchased; depreciation is just accounting allocation thereafter.
In your business
- →List every fixed cost annually and challenge each one
- →When revenue drops, fixed costs are what bankrupt you - cut them first
- →Variable-ize where possible: contractors instead of full-time hires for project work