Most businesses experience both fixed expenses and variable expenses. Knowing the difference is important, especially if your organization reimburses employees for their business vehicle expenses.
Quick Answer: What Are Fixed and Variable Vehicle Costs?
Fixed vehicle costs are expenses that remain relatively stable regardless of how much an employee drives, such as insurance, depreciation, registration, and license fees. Variable vehicle costs change with mileage, fuel prices, maintenance, tires, and other operating expenses.
This distinction matters because car allowances, mileage reimbursement, and FAVR handle these costs differently. A flat car allowance may not adjust when mileage or fuel costs change, while a cents-per-mile reimbursement may not fully account for fixed costs. FAVR separates fixed and variable costs so reimbursement can better reflect employee mileage, location, and vehicle expenses.
The difference between fixed and variable costs
Whether you are operating a business or managing a household budget, you have encountered both fixed and variable expenses. The difference between a fixed cost and a variable cost depends on how often the cost changes.
A fixed cost is an expense that stays relatively unchanged each month, regardless of business output. A variable cost frequently increases and decreases with production output or market prices. A "fixed and variable rate" reimbursement is a payment that covers both expense types.
Managing fixed and variable costs can be a challenge. Understanding the difference between variable cost vs fixed cost matters because the two categories require different approaches when planning budgets or issuing reimbursements. When comparing, fixed costs must be accounted for first, since they remain steady regardless of whether any goods or services are produced. If you’re still asking what fixed costs are, think of expenses like rent, insurance, or salaries.
Examples of Fixed and Variable Vehicle Costs
Fixed vehicle costs may include:
- Auto insurance
- Depreciation
- Registration fees
- License fees
- Personal property taxes, where applicable
Variable vehicle costs may include:
- Fuel
- Maintenance
- Oil
- Tires
- Repairs tied to vehicle use
Employers should understand both categories before choosing a car allowance, mileage reimbursement, or FAVR program.
How fixed and variable costs affect businesses
All businesses should take both sets of costs into account when budgeting, setting prices, and pursuing growth. Any organization that pays a car allowance or reimbursement should also distinguish between fixed costs, such as insurance, and variable costs, such as fuel.
Employees, such as sales representatives, will incur fixed expenses regardless of whether they have a productive month with numerous trips. Only their variable expenses will increase if they increase their productivity by driving more. Some reimbursement models, however, do not properly account for the fixed portion of expenses.
Mileage reimbursements and car allowances
When creating a mileage reimbursement or car allowance program, separate fixed from variable expenses. Otherwise, negative consequences to your bottom line may follow:
- Costs exceed the budget unexpectedly
- Insufficient reimbursements, reducing retention
- Over-reimbursements, reducing cost control
- Unresponsive to changing expense needs
So, what vehicle expenses fall under variable costs vs. fixed costs?
Examples of fixed vehicle expenses
Fixed vehicle expenses are the costs associated with owning a car, regardless of how often you drive it. These costs remain relatively stable from month to month or even year to year:
- Auto insurance
- Depreciation
- Personal property taxes
- Vehicle license and registration fees
Does your company's mileage reimbursement take into account insurance and depreciation? These may constitute over 60% of annual vehicle expenses, but mileage rates may under-reimburse them.
Why is depreciation a fixed cost?
Vehicle depreciation is a business expense and should be reimbursed. A decrease in value counts as a fixed cost because it occurs steadily over time according to a schedule. This makes it a predictable expense.
The business portion of an employee's vehicle use determines the percentage of depreciation that a car allowance should reimburse. A business might exclude this expense from the car allowance calculation because it is not a direct expense. A mileage rate may under-reimburse the expense because the driver does not drive enough miles to cover fixed costs.
Variable vehicle expenses to be reimbursed
The variable costs of car ownership could be considered operational costs. Driving more or less will have a significant impact on these costs, as do fluctuations in market prices:
- Fuel
- Oil
- Maintenance
- Tires
How Car Allowances Reimburse Fixed and Variable Costs
A standard car allowance pays the same amount each month. That can make it easier to budget for predictable fixed costs, but it may not keep up with variable costs such as fuel, maintenance, tires, or changing mileage levels.
Car allowances can also create fairness concerns because employees drive different amounts, work in different territories, and face different vehicle expenses. If the allowance is taxable, the employee’s take-home value may be reduced by payroll and income taxes.
In states with employee expense reimbursement rules, employers should review whether a taxable car allowance adequately covers necessary business vehicle expenses.
How Mileage Reimbursement Handles Fixed Costs
Cents-per-mile reimbursement is simple because employees are paid based on approved business miles. This approach can work well when mileage patterns are predictable, and employees have similar vehicle costs.
The challenge is that fixed costs do not rise in direct proportion to mileage. Insurance, registration, license fees, and some depreciation costs exist whether an employee drives many business miles or only a few. As a result, a single cents-per-mile rate may over-reimburse some high-mileage drivers and under-reimburse some lower-mileage drivers or employees in higher-cost regions.
How a Fixed and Variable Rate Allowance Works
A fixed-and-variable rate allowance, often called FAVR, separates reimbursement into two parts. The fixed payment is designed to account for ownership costs such as insurance, depreciation, registration, and license fees. The variable payment is designed to account for operating costs such as fuel, maintenance, and tires.
FAVR can be tax-free when IRS requirements are met, and business use is properly documented. Because the program accounts for both mileage and localized cost data, it can provide a more accurate alternative to a flat car allowance or one national cents-per-mile rate.
Benefits of a FAVR Program
A properly designed FAVR program can help employers:
- Separate fixed costs from variable costs
- Adjust reimbursement for mileage and location
- Reduce over- and under-reimbursement
- Improve transparency in how payments are calculated
- Support tax-free reimbursement when IRS requirements are met
- Improve consistency across mobile employees
- Full compliance with state labor codes like CA Labor Code 2802
Switching to a FAVR vehicle plan
Switching from a taxable car allowance or from a cents-per-mile rate can yield specific benefits:
- Removing taxes can yield a higher benefit for employees at a lower cost to the employer
- Switching from the IRS mileage rate is more scalable, protects low-mileage drivers, and increases cost control
A FAVR vehicle program can be challenging to administer initially due to the IRS regulations involved. However, with the right guidance and support, this can be a cost-effective move.
To learn more about how a FAVR car allowance could work for your organization, schedule a call. Or use the mBurse FAVR savings calculator
Or take a deep dive with our ultimate guide to FAVR reimbursements.
FAQs About Fixed and Variable Vehicle Costs
What are fixed vehicle costs?
Fixed vehicle costs are expenses that stay relatively stable whether an employee drives a little or a lot. Common fixed vehicle costs include auto insurance, depreciation, registration fees, license fees, and personal property taxes where applicable.
What are variable vehicle costs?
Variable vehicle costs vary with mileage, fuel prices, driving conditions, and vehicle use. Common examples include fuel, oil, maintenance, tires, and repairs tied to business driving.
Why do fixed and variable costs matter for vehicle reimbursement?
Fixed and variable costs matter because different reimbursement methods handle them differently. A flat car allowance may not adjust when mileage or fuel costs change, while a cents-per-mile reimbursement may not fully account for fixed ownership costs. A FAVR program separates fixed and variable costs to improve reimbursement accuracy.
Does mileage reimbursement cover fixed vehicle costs?
Mileage reimbursement can include fixed costs in a single cents-per-mile rate, but fixed costs do not rise directly with mileage. This means a single mileage rate may over-reimburse some high-mileage drivers and under-reimburse some lower-mileage drivers or employees in higher-cost regions.
How does a car allowance handle fixed and variable costs?
A car allowance pays the same amount each month, which can make budgeting easier. However, it may not adjust well to changes in fuel prices, maintenance costs, mileage levels, or regional cost differences. If the allowance is taxable, the employee’s take-home value may also be reduced.
How does FAVR handle fixed and variable vehicle costs?
FAVR separates reimbursement into a fixed payment and a variable payment. The fixed portion can account for ownership costs such as insurance, depreciation, registration, and license fees. The variable portion can account for operating costs such as fuel, maintenance, and tires. When IRS requirements are met and business mileage is properly documented, FAVR can support tax-free reimbursement.