Variable costs are costs that change in proportion to a business’s production or sales volume. They are variable because increasing production or sales volume causes a corresponding increase in variable costs. These costs are part of a cost accounting, and are essential for determining a company’s profit margins and operating efficiency.
Unlike fixed costs, variable costs are not constant and can be directly attributed to the production of goods or services. Understanding the different types of variable costs and the formula for calculating them can help companies make informed decisions about pricing, product offerings, and cost-saving measures.
Types of Variable Costs
Here are some common types of variable costs:
- Raw Materials: The cost of the materials used to produce goods, such as the cost of the fabric used to make clothing, or other materials like steel, wood, or plastic that are utilized in the manufacturing process.
- Direct Labor: The cost of wages, salaries, and benefits paid to employees directly involved in the production process – for example, assembly line workers.
- Commissions: The cost of commissions paid to sales representatives is based on the number of sales they make.
- Utilities: The cost of electricity, gas, and water used in the production process.
- Shipping: Expenses associated with the transportation of goods or materials from one location to another and the cost of shipping finished goods to customers.
How to Calculate Variable Cost
To calculate the total variable cost, you need to know the total quantity of output and the variable cost per unit of output. The variable cost formula:
Total Variable Cost = Total Quantity of Output x Variable Cost Per Unit of Output
For example, if a company produces 1,000 units, and the variable cost per unit is $10, the total variable cost for the production of these units would be $10,000:
Total Variable Cost = 1,000 units x $10 per unit
Total Variable Cost = $10,000
Using this simple formula, businesses can calculate their total variable costs for any level of production, which can help them make informed decisions about pricing, production levels, and profitability.
Why Is Variable Cost Analysis Important?
Variable cost analysis is important because it helps businesses understand their cost structure and identify areas where they can improve efficiency. By analyzing variable costs, companies can determine the profitability of each product or service they offer and decide whether to discontinue or restructure them.
Variable cost analysis also helps to plan for changes in production volume and develop pricing strategies in order to remain competitive in the market. Another significant benefit is that it helps businesses determine their break-even point.