What is Fixed Cost?
A fixed cost is an expense that remains unchanged in total within a relevant range of activity, regardless of changes in production or sales volume. Examples include rent, base salaries, insurance, depreciation of plant, and statutory license fees. Fixed cost per unit declines as volume increases because the same total is spread over more units.
How It Works
- Identify costs that do not vary with short-term volume swings.
- Confirm the relevant range; beyond it, capacity must expand and costs step up.
- Allocate fixed cost to units only for inventory valuation, not for decision making.
- Use contribution margin (revenue – variable cost) to cover fixed costs.
- High fixed cost businesses have high operating leverage and earnings sensitivity to volume.
Saudi Context
Saudi commercial real estate rents in Riyadh, Jeddah, and the Eastern Province plus mandatory GOSI and Saudization-related payroll create significant fixed-cost bases for SMEs. Cash-flow modeling during slow seasons (summer, post-Hajj) must account for these costs continuing irrespective of revenue.
Example
A clinic pays SAR 25,000 monthly rent and SAR 60,000 in base salaries, totaling SAR 85,000 of fixed costs. Whether the clinic serves 200 or 500 patients in a month, these costs are unchanged. Adding patients improves operating leverage without increasing the fixed base.