Question

Why might variable costs be considered less risky than fixed costs? (Fixed costs don’t change in relation to sales, so they still have to be paid, even if there is no income.) What happens if you don’t sell any cookies one month or sell only a hundred? The riskiness of fixed costs demonstrates why it’s a good idea for entrepreneurs to have a cash reserve in the bank equal to three months of fixed costs.

Answer 1

cash reserve in the bank equal to three months of fixed costs

Liquidity is an important factor for a company to run day to day activities,ie having enough cash in company to meet current expenses and cost is important factor.

Holding lower cash is riskier for a business to meet the needs and at the same time holding too much money is also not appreciated, but the excess money should be invested in projects.

variable costs be considered less risky than fixed costs

Total Variable cost is increased with level of actiity. If higher level of Actiity(eg:productn) is performed higher will be variable cost, at the same time more revenue can be earned with more production.

At the same time fixed cost remain constant at any level of production,even for a lower activity level the Fixed cost will be higher and considered riskier.

don’t sell any cookies one month or 100

In this case even we dont sale any cookies fixed cost will be same as that of when we sell 100units. The Higher the fixed cost the more the loss will be.