What is the difference between fixed and variable costs?

Fixed and variable costs are fundamental concepts in cost accounting and financial management, and understanding the distinction between them is crucial for analyzing business operations and profitability.

Fixed costs are those expenses that do not change with the level of production or sales. They remain constant regardless of how much a company produces, at least within a certain range of activity. Examples include rent, salaries, and insurance. This characteristic allows businesses to predict these costs reliably over periods of time, making budgeting and financial forecasting easier.

On the other hand, variable costs fluctuate directly with the level of production. These costs increase as production increases and decrease as production decreases. Common examples of variable costs include raw materials and direct labor costs linked to the number of units produced.

The correct answer encapsulates this fundamental difference. It clearly states that fixed costs remain constant while variable costs change with production levels, highlighting the contrasting nature of these two types of costs. Understanding these distinctions helps businesses in making informed decisions about scaling operations, pricing products, and analyzing profitability.