What is a Variable Cost and why does it fluctuate?
Common Variable costs fluctuate based on the trading activity in the business. These are the expenses that will fluctuate with business activity and when the business increases production. The more business you get and the more the company produces, the higher these costs will be.
Many costs will fluctuate in the business based on the number of sales. However, it is important to note that not all variable costs increase/decrease in the same way.
Types of variable costs including Examples:
- Raw materials
- Transaction fees, like bank charges and payment gateway charges
- Human resources required for increased business activity for example employees on payroll or contractors outsourced for services.
- Advertising and Marketing costs
- Travel costs for example Fuel
- Repairs and Maintenance
- Commissions and Salaries
- Postage and Courier
Understanding the concept of Variable Costs
The total expenses incurred by any business consist of Variable and Fixed Costs. VC are dependent on production output or sales.
The VC of production is a constant amount. It stays the same per unit produced. Variable costs increase when the volume of production and output increases.
Calculating the total Variable Cost for production
The total variable cost is simply the quantity of output multiplied by the VC per unit of output:
Total Variable Cost = Total Quantity of Output X Variable Cost Per Unit of Output
Average Variable Cost for goods or services
Variable cost and average variable cost sound similar, however each describe an entirely different value of expenses.
Variable Cost is usually describing the variable cost for a single product.
Average Variable Cost is an analyzed of these costs over a period or production level.
The formula to calculate average variable cost is: AVC = Total Variable Costs / Total Output
Understanding the difference between variable and fixed costs
Fixed costs remain the same regardless of production output. Whether a company makes sales or not, it must pay its fixed costs, as these costs are independent of output.
Why do Variable Costs matter
Variable costs can fluctuate till it becomes much harder to budget and forecast for future expenses of the business.
Variable cost fluctuations are the leading cause of Small Businesses not having the working capital they need.
Working capital is directly related to your ability to budget and forecast. Small businesses need to use a professional accountant to assist them with their costing processes.
VC influences total production cost.
Do VC's differ from fixed costs?
Yes. Fixed costs remain the same irrespective of the level of trading in the business. Whereas Variable Costs fluctuate.
Examples of fixed costs:
- Rent
- Salaries
- Subscriptions
Frequently asked questions
Is marginal cost the same as variable cost?
Marginal cost refers to the increase to produce one more unit. Marginal cost is the total cost of production, variable and fixed.
What is the total variable cost formula?
The formula is:
Total Variable Costs = Cost per unit x Total number of units sold.
But wait. What about Stepped costs
Stepped costs increase at certain levels of growth. For example, you might add 10 Employees to produce another 1000 Sales however you end up increasing sales by 1200.
The relationship is not as directly linked as with a true variable cost. The salary costs only increase as the business experiences bottlenecks in their sales pipelines.
What is the fixed cost per unit of output
Fixed costs are expenses that occur irrespective of the trading activity. Fixed costs are expenses that do not change with the level of production. These costs can be calculated by dividing the total fixed costs by the number of units produced.
Fixed costs are not always tied to the production of a unit or service. You can calculate the fixed cost per unit by dividing the total fixed costs by the number of units produced.
How does Variable cost affect Net Profit?
The bottom line or Net profit will increase by the difference between the VC and the selling price per unit.
What are the variable and fixed costs in economics?
Fixed costs are expenses that remain the same no matter how much a company produces, such as rent, property tax, insurance, and depreciation. Variable costs are expenses that vary based on a company's production and sales levels. These costs include labor, utilities, commissions, and raw materials. Labor costs, for example, increase as production levels rise.
Utilities, such as electricity and water, also increase with higher production. Commissions paid to salespeople are another example of variable costs. Raw materials, like wood or metal, are also considered variable costs.
Where do fixed and variable costs fit into a Profit and Loss statement?
Generally, the VC will form part of the cost of goods sold as these are costs that are directly linked to the production of the goods or services, whereas the fixed costs would form part of other operating expenses.
What are 7 Simple Ways for Businesses to Reduce Variable Costs?
- Scrutinize Your Products & Services Regularly
- Negotiate Better Terms With Your Suppliers
- Manage Wage & Salary Costs
- Always Monitor Your Variable Expense Average
- Reconsider Your Budgeting Strategy
- Invest in Advanced Business Technology
- Use Virtual Payment Cards
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