Fixed Charges

A recurring business expense made in regular intervals that cannot be changed without negotiations

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What are Fixed Charges?

Fixed charges, sometimes known as fixed costs or fixed expenses, are business expenses that occur periodically and are independent of the operational tempo of the business. It is in contrast to variable costs, which vary with business volume. Some examples of fixed charges include principal and interest payments on debt, insurance, taxes, utilities, general salaries, rent, and capital lease payments.

These overhead expenses typically satisfy a business’s obligation to third parties. A business like a startup may not even be generating revenue from producing a good or offering a service. Lenders are interested in costs of comparable legal importance to the business’s principal and interest obligations, especially when insufficient cash is available to satisfy all parties.

The second definition of fixed charge is a specific legal claim over an asset, in other words, a creditor’s security interest over the collateral. This second definition contrasts with that of a floating charge, a concept used by lenders and legal counsel to refer to the granting of security interests.

Fixed Charges

Certain expenses are fixed by agreements, such as pension fund contributions, which are also included under fixed charges. Lenders often look at fixed expenses to determine the debtor’s ability to repay a loan.

Key Highlights

  • Fixed charges (or fixed costs) are periodic business expenses independent of the business activity, in contrast to variable costs.
  • Fixed charges include expenses such as principal and interest payments on debt, insurance, taxes, utilities, salaries, and rent and lease payments.
  • Fixed charges are expenses independent of the output level (goods or services), unlike variable costs, which are proportional to the business volume.

What are Examples of Fixed Charges and Where Can These Be Found?

Fixed charges are found on the income statement as expenses and, sometimes, on the cash flow statement. Certain capitalized expenses are on the balance sheet. As fixed charges are business expenses that occur regularly and are independent of the business volume, they are relatively stable compared to revenue or other measurements of business activity.   

Contracts entered into or exited by the business will change the total, regardless of business volume. It will reflect as a lump change during the period that it occurs. This is unlike proportional changes in expenses relating to business volume, such as the cost of goods sold.  

In the examples table below, one can note that fixed charges usually mean an outlay of cash to a third party, except for differences in taxes due to accounting treatment or non-cash expenses such as depreciation and amortization.

Fixed Charges - Example

What Makes Fixed Charges Unique?

These costs are often incurred via contracts that compel performance (for example, making a rent payment or paying a salaried staff). Good business practice is to ensure sufficient cash flow is available to cover payments of fixed charges on time and as agreed, such as by determining the break-even point.  

Some options to negotiate the payment terms may be available. For example, a payment plan installment agreement[1] to catch up on tax arrears. Another may be to furlough staff due to a temporary slowdown or shutdown to prevent permanent layoffs.  

Lenders may choose to narrow down the inclusions or exclusions of fixed charges within the contractual term of a lending agreement. Certain expenses, such as pension fund contributions, may be included, while others, such as utilities, may not, depending on how meaningful the expenses are to business cash flow.  

Lending agreements need to suit the lender and debtor’s objectives. Lenders want to understand the cash available to cover fixed charge obligations compared to the total fixed obligations. The fixed charge coverage ratio is one way to evaluate the debtor’s ability to repay debt, as well as the debtor’s capacity to take on debt within the capital structure. 

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Article Sources

  1. IRS – Payment Plans Installment Agreements
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