Variable cost is the bread and butter of exporting businesses. If you want to make a profit, you can start by working out the variable cost of your product or service. It’s a useful tool for calculating anything from your product’s contribution margin to your company’s profit.
Think of your variable cost as the sum of the costs incurred in making a product. Therefore, your variable cost rises if your company’s production increases and falls if production decreases.
Another common type of cost is fixed costs — these don’t change in proportion to your company’s production or sales volume.
This article at a glance
Variable costs are important when determining a specific product’s contribution margin and are used to calculate your company’s profit. Find out more about variable costs, some examples, and how you can calculate your variable cost using a formula.
Your total company expenses = Variable costs + Fixed costs.
To understand variable costs, we first need to know the difference between fixed and variable costs, which make up the total company expenses in that financial year.
As the name suggests, variable costs can change based on how much a company produces and sells in that time period. Some common examples of variable costs include raw materials, direct labour, commissions, utility expenses, and shipping and freight.
On the other hand, fixed costs will not change regardless of whether the company’s goods or services are produced or not. Essentially, this means that a company must always account for fixed costs before any other costs. Some common examples include lease and rent expenses, property tax, salaries, business insurance, depreciation and interest payments.
Here’s an example to demonstrate how fixed and variable costs work.
Company ABC produces soft toys. They rent a machine for $ 5000 each month to produce these toys, and each toy costs $ 2 to produce. In the month of June, they produced no toys. October, = 2000 toys. December, 5000 toys. What are Company ABC’s fixed and variable costs?
Variable cost analysis is used to analyse a company’s expenses, pricing, and profitability.
Break-even point = Fixed costs/contribution margin (revenue — variable costs)
To know your company’s break-even point, you need to calculate how many products you must sell to make a profit.
Revenue is gained from selling products to recover the cost of manufacturing. Pricing your product too high will blunt its competitive edge in a cutthroat market. Pricing them too low will make it difficult to sustain the company.
A variable cost analysis will help a company ensure how much it should price a product in order to earn profits from that sale.
Some companies aim to increase revenue by doubling their output in the next financial year. But doing so will proportionally increase their variable costs. Knowing the current variable cost using a variable cost analysis will determine whether any strategic plans for growth, contraction, or expansion are feasible.
Variable costs and Average variable cost are often interchangeably used, but they’re vastly different terms.
What is the average variable cost? Average variable cost = total variable costs / total output
Variable costs are used to describe the variable cost of a single product, whereas average variable cost compares variable costs to what has already been produced by the company, and can vary depending on price increases.
For example, utility bills are a variable cost. In June, Company ABC’s utility bills came up to a total of $ 2000. However, in September, due to the government’s increase in water prices, the utility bill came up to $ 3000.
The current variable cost will be $ 1000 higher than before, but the average variable costs won’t fluctuate that much, as it’s divided by the total output of the company.
The most common types of variable costs include:
Unsure if your cost is variable? A rule of thumb is that if a cost may increase or decrease depending on your company’s activity and production, it’s most likely a variable cost.
One type of cost that is often confused by entrepreneurs is salary and labour.
Is salary a fixed or variable cost? Is labour a fixed or variable cost?
Salary is a fixed cost. This is because it’s not determined by production or company revenue. For instance, Employee A earns $ 2000 per month, every month. The salary your company gives out will not change, even if you produce no products that month, or if you produce 2000 products that month.
However, labour is a variable cost. The difference is when labour costs are not part of an employee’s salary, or if you hire direct labour that does not receive a regular salary payout from you.
For example, piece rate labour — where workers are paid based on the number of units they make or pack. Another example is employees who are paid on an hourly basis or paid based on billable hours. This is when a company bills a client for only the hours its employees work.
Fixed costs are simply added together to get a company’s total fixed costs.
Fixed cost 1 + fixed cost 2 + fixed cost 3 = total fixed cost
But variable costs must be multiplied. Sounds confusing? Here’s an easy formula.
Production output x variable cost per unit = total variable cost
Company ABC produces 10 000 units of soft toys. One unit costs $ 2 to produce.
Production output (10 000 units) x variable cost per unit ($ 2/unit) = total variable cost of $ 20 000
There are many expenses that need to be paid out by your company on both a regular and irregular basis — and these are part of your company’s variable and fixed costs. Make your payment easier by choosing a simplified and smart solution to handle payments.
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