Variable cost - What is a variable cost?
A variable cost refers to a business expense that is affected by fluctuations in production and so changes between given periods
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Variable costs are encountered regularly by businesses. A variable cost is closely tied to the production levels of the business - they rise when production levels rise and fall when they drop.
Variable costs therefore differ from period to period, depending on the amount of production. The costs associated with variable costs are those that contribute directly to the goods or service being offered by a business.
Why variable costs are important
Variable costs are not only a major part of running a business, they also can be key to turning breaking-even into profits. Or existing profits into larger profits.
Keeping track of variable costs can provide crucial insight into where cash outflow is going and to what extent. The profits of a business can be directly impacted by adjusting the variable costs but maintaining sales prices.
What variable costs mean for your business
On the other hand, rising costs aren’t necessarily a negative when viewing a business’s income statement. It can indicate an increase in sales, which would then require more costs in order to produce the amount of goods in demand. This then translates to increased revenues over a longer term.
However, it should be noted that revenues should grow more quickly than expenses. For example, a business experiences revenue growth of 5%, with the cost of goods sold rising by 3%, this indicates that costs have probably declined. If they can be reduced further, this would serve to increase profitability.
Examples of variable costs
Costs that vary depending on your production are all considered variable costs. The differences from payment period to payment period can be significant or minor depending on the production levels of the given period.
Common variable costs for businesses include:
- Raw materials: the materials purchased by the business used to create finished products
- Packaging: the materials used to pack goods for shipment to customers
- Shipping: the cost of shipping orders to customers
- Labour: hours directly associated with the production of goods/services
- Commission: payments made to employees based on sales
- Credit card fees: the costs associated with using credit cards for payments
These examples are general costs that a business might experience to give an indication of what kinds of expenses are affected by production.
Variable cost vs fixed cost
Businesses deal not only with variable costs, but also with another main form of expense known as fixed costs. These costs stay mainly steady, as they are not affected by production level changes.
Fixed costs can have a variable element, but in general, they refer to expenses that are more predictable and are not tied to production levels. Fixed costs can include expenses such as rent, electricity usage, etc.
Variable cost equation
The equation for variable cost can help you determine the total variable cost:
Variable cost per unit produced X Total quantity of units produced = Total variable cost
This equation can be used to determine the total of variable costs involved in the manufacturing process of a business.
Variable costs and accounting software
The first step in keeping track of variable costs is to ensure that all expenses, whether variable or fixed, part of daily operations or the random business lunch, are all recorded accurately and in a timely manner.
Stay on track with dashboard graphs that give you a visual on your income and expenses over a selected period, making it even simpler to stay on top of your business.