| Cost classification | Fixed costs | Variable costs |
|---|---|---|
| Definition | Stay constant regardless of output | Scale up or down with volume |
| Examples | Rent, salaries, software subscriptions, insurance | Payment processing fees, COGS, hourly contractors, materials |
| Behavior at low volume | Painful: same cost, less revenue | Naturally lower: you spend less when you sell less |
| Behavior at high volume | Highly leveragable: fixed cost spread over more units | Grows linearly with revenue |
| Forecasting | Predictable: locked in | Requires assumptions about volume |
| Strategic implication | High fixed = operating leverage but breakeven risk | High variable = lower margins but flexibility |
Fixed costs
Fixed costs stay flat no matter how much you sell. Rent, base salaries, software subscriptions, insurance. Whether you close 10 clients this month or 100, the number barely moves. Fixed does not mean permanent, though. These costs still change when you sign a new lease or add a tool. They just don't move with your sales volume.
What makes fixed costs matter is operating leverage. Once they are covered, most of every new dollar of revenue falls straight to the bottom line. Say you run $50K a month in fixed costs. At $60K of revenue you are barely ahead. At $100K you have added $40K and kept nearly all of it, because the rent and salaries were already paid. That is why a company built mostly on fixed costs can look unremarkable at low volume and then throw off real margin once it scales.
Variable costs
Variable costs move with volume. Cost of goods sold, payment processing fees, shipping, sales commissions, the contractor hours you bill against a project. Sell twice as much and these roughly double. Whatever is left after you subtract them, the contribution margin, is what actually goes toward covering your fixed costs.
In practice nothing is perfectly variable. Shipping has minimums, commissions have a base, your payment processor charges a monthly floor. The goal is not to classify every line item down to the penny. It is to know which costs ride along with revenue and which ones sit there whether you sell anything or not.
Why the distinction matters for scaling
Your mix of fixed and variable costs tells you what happens to margins as you grow. Lean heavily on fixed costs and margins widen as revenue climbs, because you are spreading the same base over more sales. A business that is 70% fixed can double revenue and see profit triple. Lean on variable costs instead and margins hold roughly steady at any size, because most of your costs grow right alongside the top line.
This is the real reason software and services feel so different to run. Software leans fixed, which is how it throws off the margins investors love once it scales. Services lean variable, which is why growing one usually means hiring in step with revenue. Neither structure is better. But knowing which one you have should shape how you price, when you hire, and how hard you push on growth.
Mixed costs and how to handle them
Most real costs are a bit of both. A sales rep on base plus commission. A cloud bill with a minimum commitment plus usage on top. Headcount is the classic case: your team absorbs growth for a while, then you have to add someone, and margin compresses until that hire is fully busy. Knowing where those step-ups land is half of cash flow planning.
When you need to split a mixed cost into its parts, the high-low method is the fast way. Take your highest-volume month and your lowest, divide the change in cost by the change in volume, and you have a rough variable cost per unit. Whatever is left is the fixed piece. It is not exact, but it is close enough to build a budget on.
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