The costs of running your business are one of those things that never changes. Variable costs are when expenses change relative to the business’s operations. Variable costs, along with fixed expenses play an important role in revealing the profitability of your company.

Let’s now look at variable cost, one of the most crucial financial figures for a growing company.

Let’s get started right now!

What is a variable price?

Variable costs, also known as variable expenses, are the cost of raw materials, distribution and labor for each unit of product/service you sell. Variable costs can increase or decrease depending upon the volume of your company’s production. They rise as production increases, and they fall as production decreases.

Variable costs can vary as they can change depending on how much you sell your product/service. You will make more money if you sell more units. However, some money must be spent to produce more units. To make a profit, you’ll need to make more units.

Certain industries, such as airlines, have high fixed costs and are more vulnerable to competition. Because they require large amounts of investment in machinery, and other physical items to begin up, this is why they are less vulnerable to competition.

Industries with high variable costs like the service sector, which relies heavily on labor, are more susceptible to competition, as less investment is needed to start up.

Variable cost examples

It is easy to see if the cost changes or remains the same each month. This is one of the easiest ways to determine if it is fixed or variable. While there are many variable costs that businesses incur monthly, these are the most prevalent:

• Cost of raw materials. These are probably the most variable costs for businesses. Your finished product is made from raw materials. Their cost will vary depending on the level of production.

• Direct labor costs (i.e. hourly wages) Managers may ask employees to work extra hours and require overtime pay. When production levels are high, additional employees can be hired or furloughed. Production can have an impact on all wages, but only wages for direct employees.

• Supplies for manufacturing. These items directly relate to the manufacturing process. For example, gloves for machine workers and equipment cleaning supplies. Manufacturing supplies are considered variable costs because they can be affected by production labels.
• Commissions. Commissions. If your production is high, you should pay more commissions. Or your sales staff isn’t doing its job.

• Distribution costs include shipping and restocking. Shipping costs will be charged to customers if they are buying directly. Freight costs will apply if the order is shipped in bulk to a distributor or store. Shipping costs rise with increasing production.

• There are transaction fees for credit cards. These fees are charged when you use credit cards to make payments.

• Online payment partners. PayPal and other apps often charge businesses per transaction. Customers can then check their purchases via the app. You will need to pay more for the app the more orders you receive.

Let’s look at a quick example. Imagine that you own an E-commerce company and have to hire staff on an hourly basis. The number of orders will determine the hours worked. Shipping costs are an expensive variable cost that can impact your business. Your company also has a salesperson, who receives a commission and a performance bonus.

Variable costs are important

Variable costs are essential for a business because they can have a significant impact on how the company spends its money. Variable costs can vary depending on the strategic goals of your business. Variable expenses that are low will allow you to have more money for other areas because there won’t be any sudden costs.

When looking at your income statement, it’s important to remember that rising costs are not necessarily a bad sign. This can indicate an increase in sales. However, this would mean that there are more costs to produce the goods in demand. This means that revenue will increase over time.

The key to understanding where cash is flowing and how much can be found by keeping track of variable expenses. Variable costs can have a direct impact on your business’ profits. However, you should maintain sales prices.

How to calculate variable cost

To calculate your total variable cost, you could use the following formula:

Total variable costs = Variable cost for each output unit x Total output quantities

These are the steps to follow when using this formula for determining your company’s total variable costs: 

1. All variable expenses related to the production of one product unit are identified

 2. Add all variable costs required to produce one unit to calculate the variable cost of one unit 

3. Multiply the variable expenses for one product unit with the number of units produced. This calculation will give you the total variable costs.

Your company might want to calculate the total variable costs required to produce 100 products. First, determine the variable cost per product to calculate the total variable costs. These numbers are what you will get:

• Direct material costs per unit: $10
• Direct labor costs per unit: $20
• Shipping costs: $8

Variable expenses for producing one unit are $10 + $20 + $8 = $38. This means that you will need to spend $38 in order to produce one product.

The total variable cost of producing 100 products is $38 x 100 = $3800. The total variable cost to produce 100 units would be $3800.

Variable costs vs. Fixed costs vs. variable costs

Fixed costs are another important cost that is often incurred when producing products or services. These are expenses that will not change regardless of the output of your production. Fixed costs must be paid regardless of whether your business has sales.

Fixed costs are predictable because they remain constant from month to month. If your fixed costs are $1,000 per month, then you know that you will need to make at minimum that amount to keep your business afloat.

But, predictability can have side effects. Fixed expenses, like rent and insurance fees, are hard to alter. Fixed costs are often the most difficult to reduce expenses and increase profit margins. Variable costs are more flexible. Variable expenses are often the first to be cut when companies want to improve their profit margins.

What is the cost of salary? 

Salary is a fixed expense that doesn’t change based on revenue or production. This is a recurring expense that is paid out in a fixed amount.

Variable expenses can be added to a salary. One of these is piece rate labor. Workers are paid according to the number of units they produce. Another variable expense is employees who are paid on the basis of billable hours. This happens when a company bills a client for hours worked by its employees. They only get paid according to the number of hours they can bill.

Salespeople are only paid when they sell products or services, so the commission is a variable cost.

How to effectively manage variable costs

Variable expenses are not tied to output changes. However, this does not necessarily mean that your variable costs will increase in a linear fashion as your business expands. This means that if your production increases by 10%, that doesn’t necessarily mean your variable expenses will increase by the same amount.

There are many options to help you manage variable costs efficiently. These are just a few:

1. Find the average annual cost for each variable expense 

Avoid looking at the 12 most recent months when determining the annual average variable cost. Take the time to review three years worth of variable cost averages.

This will allow you to account for any anomalies that could affect your average expense. You should not take steps to reduce variable costs permanently. Instead, use the highest average amount.

2. A buffer is recommended

After you have determined the average cost for each variable, you should add a buffer. A buffer of between 3% and 5% should be sufficient to cover price rises, as well as any anomalies that could lead to an unusual year for the expense. You can be more prudent and have a budget to support it.

3. Always compare actual spending with estimates

Compare what you spent to your estimates at the end of each month. What are your results? Notify us if you were within or outside your budget for each expense category.

You would be likely to achieve a similar result next year if you had enough money in your cushion. You should review your financial situation and determine where you can transfer some or all of your money to your variable expenses fund.

4. If necessary, reduce your variable costs

You may want to reduce your variable expenses if your company is experiencing difficulties with predictability or trying to cut costs.

You should analyze the process thoroughly and determine if you can achieve similar output, even if you make cost-effective adjustments to it. Some examples include:

• Evaluate your product or service. There are many businesses that offer different services and products. Although you could sell a package of products, it’s only one part that generates revenue. Do you need to eliminate certain features? Is there a way to deliver your product/service faster?

• Raw materials Are you using the best-priced materials? Can you buy it in large quantities? Would you have more problems with your product if you used better materials?

• Labor. Can there be anything that can’t be automated or outsourced that doesn’t impact quality? Are you able to increase the efficiency of your workforce and produce more by giving them specific tools and services?

• Commissions. Commissions. While it is possible to reduce commissions, it is better to reduce other costs than reducing employee incentives like commissions. This could affect your human resources management and even impact your sales.

Remember that just because something is done in one way always doesn’t make it right. You may find yourself overwhelmed as your business grows and you don’t have the time or resources to take down your existing processes and systems. This could be a great way for your company to identify areas where you can save money, considering how quickly the market changes and how costly new products can become.

5. Save money for variable costs by opening a savings account

To help with price rises, you can deposit the extra money that you have saved if your budget was well-planned. This will allow you to draw on your savings account during times when your expenses are more than usual.

6. Annually reevaluate your variable costs

It’s tempting to repeat the same variable cost projections each year in your budget, especially if you have a substantial savings account. This temptation is not to be allowed. To control your business better, it’s better to reassess your variable expenses annually.

7. Get a credit line for emergency situations

Sometimes even the best-laid plans go wrong. As a backup plan, you can consider a business credit line. You don’t have to reapply after you take your first draw. Also, you only pay interest on the amount you have borrowed.

The credit limit for line of credit is higher than that for credit cards. You can withdraw cash and have the ability to pay major expenses immediately.

The final verdict

It is crucial to understand what variable costs are and how to effectively manage them to ensure your business’s sustainability. Remember that variable costs are not to be ignored once sales increase.

We hope you have gained the knowledge necessary about variable costs from this blog post. Please let us know if you have any questions. We are always available to answer your questions!