5.7.2. Understanding Operating Costs
Fixed Costs
Fixed costs remain constant regardless of sales volume. A typical example of a fixed cost is rent. For instance, a restaurant’s rent does not fluctuate based on the number of meals served; it remains constant for the duration of the lease agreement. Other examples of fixed costs include property taxes, insurance premiums, and equipment depreciation.
Some labor costs are also considered fixed. Employees who receive a consistent salary regardless of business volume, such as full-time cashiers, managers, the head chef, and bookkeepers, represent fixed labor costs. Janitorial services also fall under this category. However, labor costs that increase with business volume should not be classified as fixed.
Basic energy costs, such as heating and lighting, are often treated as fixed costs to a certain extent. While the minimum level of energy required does not change with sales volume, additional usage due to increased business is not considered fixed. In this context, energy costs will be treated as fixed.
Fixed costs can be further divided into controllable and non-controllable costs:
Controllable Fixed Costs: These can be adjusted in the short term. For example, janitorial services may be reduced if there is no strict contract, and advertising expenses can be quickly modified.
Non-controllable Fixed Costs: These cannot be changed quickly by management. Examples include rent or lease payments and depreciation.
In basic calculations, overhead costs, which are necessary ongoing expenses for operating the business but not directly tied to food production or service delivery, are considered truly fixed costs.
Variable Costs
Variable costs fluctuate directly with sales. For example, the usage of napkins or linens increases or decreases with the number of customers served. Other variable costs include food, beverages, and some labor costs, with food costs often being the most significant variable cost. Variable costs are controllable. Management can opt for less expensive ingredients, adjust portion sizes, or reduce worker hours as needed, often on short notice. In basic calculations, the primary variable cost considered is food cost.
Semi-variable Costs
Labor costs are sometimes categorized as semi-variable because they include both fixed and variable components. Labor costs are generally controllable through effective scheduling and management. For simplicity, labor costs are often given their own category. In this context, they will be treated as semi-variable costs.
Breakeven Point
The breakeven point is the sales level at which total income equals total costs, meaning the business neither makes a profit nor incurs a loss. The formula for the breakeven point is:
Sales (S) = Fixed Costs + Semi-variable Costs + Variable Costs
Let us say a small café has the following monthly costs:
- Fixed costs (rent, insurance, utilities): $5,000
- Variable costs (food and beverage): 40% of sales
- Semi-variable costs (labor): $3,000 fixed plus 10% of sales
To find the breakeven point, we need to calculate the total costs and set them equal to the sales.
Let S be the sales needed to break even.
S = Fixed Costs (overhead)+ Semi-variable Costs (labor) + Variable Costs (food costs)
Substituting the values:
- S = 5000 + (3000+0.1S)+0.4S
Combine like terms:
- S = 8000 / 0.5
- S = 16000
The café needs $16,000 in sales to reach the breakeven point. At this level of sales, the income from sales covers all the fixed, semi-variable, and variable costs, resulting in neither profit nor loss.
