Variable Costs

Variable costs (VC) refer to costs incurred by the business that changes with changes in the volume of production of goods and services. It is also called unit-level costs. 

It is the opposite of a fixed cost, which does not change with a change in production volume. Variable and fixed costs sum to total costs, which implies:

Total costs = Fixed costs + Variable costs

The formula can be represented in 2 ways: 

 1. Total variable costs (TVC):

TVC = Total Quantity of Output * VC Per Unit of Output

 2. Average variable costs (AVC):

AVC = Sum of Total Variable Costs of All Products / Total Number of Units Produced. 

These can be explained as the costs that decrease with a fall in the production of goods and services and increase with a rise in the production volume of goods and services. 

Hence, it is said to be directly proportional to the change in production volume. These costs are generally short-term and may be quickly adjusted. They are considered essential for decision-making. 

As profits rely on their sales' success, businesses with a large share of VCs compared to fixed costs are often thought to be less volatile.

A few examples include:

1. Cost of goods sold 
2. Raw material 
3. Direct labor
4. Transportation expenses
5. Utility costs
6. Commissions and fees
7. Packaging 
8. Delivery costs
9. Billable staff or labor wages

Understanding 

This cost is known as the start-up cost because the costs are likely to change with changes in the company's production line. These costs can be budgeted by separating expenses into fixed or variable to analyze and budget the expenses accordingly.

Industries with a higher degree of variability will likely use more VCs, like manufacturing and retail. Therefore, tax is considered a variable expense when analyzing costs for the company. 

 An increase in VC determines the production and sales of goods and services. This implies that these costs are directly linked to the company's production processes. 

Some ways to manage these costs are:

1. Finding a financial product that has a fixed interest rate
2. Negotiate for discounts
3. Improvement in the production and sale of goods and services
4. Apply business technology
5. Analyze various variable costs
6. Outsource labor at a lower cost
7. Use social media to spread awareness 

The common VCs needed to start a business are direct labor and raw materials. These items allow the business to operate and earn profits. The other name for this cost is unit-level cost.

These are "short-term costs," also known as prime or direct costs. There is no compulsion to pay these costs if there is no production. These are highly dependent on the volume of production of goods and services. 

Variable Costs vs. Fixed Costs

Total costs contain variable and fixed costs. These types of costs are opposites of each other. Following are some of the differences between the two types:

It is important to distinguish between the two types of costs. This helps make business decisions and determine how changes in the level of output affect costs. 

These costs are used for costing the business' products using different methods, such as activity-based costing, process costing, etc. 

Examples

Here are some of the examples and their calculations:

1. Let's assume there are 150 strawberry packets, with the VC as $0.40 per unit. Calculate the total variable costs (TVC).

Answer 

The total quantity of output = 150

VC per unit = $0.40

TVC = total quantity of output * VC per unit 

= 150 * $0.40 = $60

The TVC for 150 strawberry packets is $60. 

2. Assume the following and calculate the TVC and total costs:

• Direct labor = $45
• Raw materials = $55
• Transportation costs = $35
• Commission and fees = $25
• Fixed costs = $200

Answer 

TVC = direct labor + raw materials + transportation fees + commission and fees

= $45 + $55 + $35 + $25 = $160

Total cost = fixed cost + TVC

= $200 + $160 = $360

3. Let's consider both variable and fixed costs to make several slices of bread:

As shown in the above table, the variable costs change with the quantity of bread while fixed costs remain constant, even when no production occurs. 

Researched and authored by Vanshika Nakul | LinkedIn 

Reviewed and edited by James Fazeli-Sinaki | LinkedIn

Free Resources

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