Fixed Charges

A type of business expense that occurs on a regular basis

What are Fixed Charges?

Fixed charges are a type of business expense that occurs on a regular basis and is independent of the volume of business. Fixed charge is an umbrella term for a variety of expenses, including principal and interest payments for a loan, insurance, taxes, utilities, salaries, and rent and lease payments.

 

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.

 

Summary:

  • Fixed charges are a type of business expense that occurs on a regular basis and is independent of the volume of business.
  • Fixed charge is an umbrella term for a variety of expenses, including principal and interest payments for a loan, insurance, taxes, utilities, salaries, and rent and lease payments.
  • Fixed expenses are different from variable expenses as the latter is dependent on the volume of business. A fixed expense is dependent on the production capacity of the company and not its real level of output, while variable costs are directly proportional to the volume of sales.

 

Fixed vs. Variable Costs

Fixed costs are different from variable expenses as the latter is dependent on the volume of business. A fixed expense is dependent on the production capacity of the company and not its real level of output, while variable costs are directly proportional to the volume of sales.

For example, a salesperson’s income may be determined by the volume of products sold by the company or by that particular salesperson. Although independent of the volume of business, fixed costs disproportionately impact a company’s bottom line based on the number of variations of products offered by the company.

 

Fixed Charge Coverage Ratio

The Fixed Charge Coverage Ratio (FCCR) calculates the repayment capacity of a borrower by using earnings before interest and taxes (EBIT) and dividing this amount by the total fixed charges of the company. Another variant is when earnings before interest, taxes, depreciation, and amortization (EBITDA) is the numerator, and the fixed charge is the denominator.

For example, an FCCR of 1.5 means that for every $1 of debt payment, the company holds $1.50 of income at its disposal. FCCR reflects the cash flow at the disposal of the company for debt repayment. Clearly, the higher the FCCR, the lower the burden of a fixed charge.

If the current profits of a business are insufficient to cover the fixed charges, the business will be in trouble with the creditors. Any decline in earnings can be detrimental for the company and create panic among its creditors and investors. Banks, analysts, and corporate finance accountants often consider FCCR while evaluating the repayment capacity of potential borrowers.

 

Related Readings

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)® certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Analysis of Financial Statements
  • Cost of Goods Manufactured (COGM)
  • FCCR Template
  • Step Costs

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