Variable Cost: What It Is and How to Calculate It

If you divide the total variable cost by the total output produced, then you receive the average variable cost (AVC). Profit-maximizing manufacturing companies use the AVC to help them decide at which time they should end the production for a specific good. If the price they receive for the product is higher than the AVC, it is one indicator of a profitable product.

• You can contact our specialists at Odint Consulting with any questions you may have about variable costs.
• Fixed cost per unit falls as the number of troops manufactured grows, and conversely, hence fixed cost per unit is inversely correlated to the amount of quantity manufactured.
• Promote cross-training among your employees to enhance workforce flexibility.
• Our specialists can help you with your questions because they have in-depth knowledge of the relevant subjects.
• Variable costs, intimately tied to production or sales volume, wield a significant influence on financial performance and decision-making.

An employee’s hourly wages are a variable cost; however, that employee was promoted last year. The current variable cost will be higher than before; the average variable cost will remain something in between. The cost to package or ship a product will only occur if certain activity is performed. Therefore, the cost of shipping a finished good varies (i.e. is variable) depending on the quantity of units shipped.

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When the manufacturing line turns on equipment and ramps up product, it begins to consume energy. When its time to wrap up product and shut everything down, utilities are often no longer consumed. As a company strives to produce more output, it is likely this additional effort will require additional power or energy, resulting in increased variable utility costs. Fixed costs remain the same month to month, which makes them predictable.

All of these factors change based on the number of people who visit the diner, how many meals they purchase, and how frequently their facility is used. Furthermore, Johnny has officially unveiled a home delivery, and as a result, he must pay for vehicle costs maintenance, both of which are dependent on the size of call-in bookings. There are several ways in which a business can reduce the total cost involved. Variable costs are usually viewed as short-term costs as they can be adjusted quickly. For example, if a company is having cashflow issues, they may immediately decide to alter production to not incur these costs. If you wisely budgeted and ended up with a little extra, deposit that amount of money in savings accounts to help deal with price spikes.

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On the other hand, a company with high variable costs and low fixed costs has low operating leverage. The contribution margin is your product’s variable cost definition selling price minus its variable cost per unit. This measurement is the money your company brings in after using sales to cover variable costs.

• All of these factors change based on the number of people who visit the diner, how many meals they purchase, and how frequently their facility is used.
• Automated machinery enhances production efficiency, reduces errors, and minimizes labor costs.
• It’s easy to separate the two, as fixed costs occur on a regular basis while variable ones change as a result of production output and the overall volume of activity that takes place.
• While sunk costs may be considered fixed costs, not all fixed costs are considered sunk.
• The commission is also a variable cost as salespeople get paid only when they sell a product or service.
• This will create a reserve that you can draw from during months when your expenses are higher than usual.
• When the bakery does not bake any cake, its variable costs drop to zero.

A variable cost is a cost that varies in relation to changes in the volume of activity. A variable cost increases as the level of activity increases; for example, the total cost of direct materials goes up in conjunction with increases in production volume. The variable cost concept can be used to model the future financial performance of a business, as well as to set minimum price points.

Are Fixed Costs Treated as Sunk Costs?

The implication of high variable costs for a company is more room for fluctuation in production output while still maintaining profitability. Conversely, companies with high variable costs will yield lower marginal profits than those with high fixed costs. Variable cost is paired with its opposite, fixed cost, in evaluating the total cost structure of a company.

If the athletic brand doesn’t make the shoes, it won’t incur the cost of leather, synthetic mesh, canvas, or other raw materials. In general, a company should spend roughly the same amount on raw materials for every unit produced assuming no major differences in manufacturing one unit versus another. Or, employees that are paid based on billable hours is another variable expense.

Understanding Variable Costs

Knowledge of these costs empowers businesses to optimize resource allocation, set effective pricing strategies, and enhance profitability. It enables agile responses to market fluctuations, facilitating cost control and operational efficiency. Further, it equips businesses with valuable insights to identify profitable ventures and streamline operations. By grasping the impact of variable costs, companies can make informed, strategic choices, laying the foundation for sustained growth and economic resilience. Comprehending the relevance of variable costs is paramount for any business aiming to thrive in a competitive landscape.

Automated machinery enhances production efficiency, reduces errors, and minimizes labor costs. The company also invests in data analytics tools to monitor and analyze production data, identifying opportunities for cost optimization. Making a strategy might assist you in managing their unpredictability. Fixed expenses, such as automobile instalments, often remain constant over time, but expenditures alter.

In general, it can often be specifically calculated as the sum of the types of variable costs discussed below. Variable costs may need to be allocated across goods if they are incurred in batches (i.e. 100 pounds of raw materials are purchased to manufacture 10,000 finished goods). Variable costs are hugely essential to a business as it can significantly impact how a company spends its money. Depending on your business’s strategic goals, variable costs can be quite high (in the case of a lot of change) or quite low. If your variable expenses are low, you’ll have more budget to spend in other areas, as there will be no sudden costs incurred.