Variable Cost Definition Explained With Examples

Variable costs are an essential part of our everyday lives. Tracking your variable costs, both at home and in business can set you up for success. 

When you track your variable costs, you are able to see where you can cut back a little or even splurge when the time is right. The smallest of changes can add up to a big difference in the long term.

What are Variable Costs?

So, what are variable costs? In the simplest of terms, variable costs are costs that vary with the volume of activity.  

In other words, the more you consume, the higher your cost. When you need more supplies, you raise your expenses. Any type of cost that fluctuates is a variable cost. 

Each one of us has varying costs weaved in and out of our daily lives. The cost of shopping for groceries each week, buying a gift for a friend, or coming up with cash for an unexpected car repair are all examples of variable costs.

Budgeting Variable Cost

Sometimes we can control our variable costs with choices; it may be the difference between going to Starbucks before work or bringing coffee from home. A tweak in your lifestyle will affect your monthly variable costs. 

This is because most variable costs are discretionary or nonessential, so they go up or down each month depending on your habits. These are the easiest to change when necessary.

If you are trying to stick to a monthly budget, you’ll want to be mindful of your variable expenses, as it is the first place to look when you need to slim down your spending. 

When tracking your spending, you will notice that not all of your costs vary each month. Some costs are called fixed costs because they are consistently the same amount. This includes things like 

You might want to speak with an accountant to help create a budget you can stick to when trying to achieve your financial goals. 

Variable Vs Fixed Costs

When looking at your costs, both personal and in business, they can be broken down into two categories; variable costs and fixed costs.

Fixed costs are the easiest to keep track of because they are predictable, such as your rent/mortgage, car payment, health insurance, and so on. At the same time, they are harder to manipulate when trying to manage a budget because we typically have less control over them. 

Like variable costs, some fixed costs may be discretionary, such as streaming subscriptions or a gym membership. Although most of them are harder to change than variable costs, I think you will find that a portion of them can be eliminated if needed. 

With the right amount of willpower, both variable and fixed costs can be controlled. If you are slightly over budget, you may need to go without Netflix or Hulu for a few months. However, if you are willing to go without for a short period of time, you will be able to have more later.

Variable Costs For Your Business

Variable costs are an integral part of doing business. As a business owner, you’ll want to make yourself very familiar with the cost of running your business and track as much as possible. 

In business, a variable cost is any cost that varies with the level of output. It is directly relevant to the number of goods or services your company produces. 

These costs will vary in proportion to the volume of activity for your business. As your company produces more goods or services, your costs will increase. If your company is doing less business, your variable costs will go down. 

Variable costs are going to differ by industry, but common examples would be packaging, raw materials, labor, and distribution costs. For example, if an online jeweler sells more jewelry one month, they must buy more packaging and pay more in shipping fees to get their product out.

As we mentioned before, total cost consists of both variable costs and fixed costs. Unlike variable costs, fixed expenses will stay the same no matter how much your company produces.

Fixed costs for your business could include staff salaries, leased equipment, website hosting fees, and loan payments.

Variable Cost and Profit 

If you are a savvy business owner, you know how important it is to track your profit margin. Maintaining your monthly profit and loss statement is a key component of doing business. 

You might have heard the saying, “A tracked number grows.” If you don’t know your monthly numbers, you are driving blindly, and that is when the most costly mistakes are made.

Doing the Math

When determining your business profits, you must know your total cost of doing business, as they are directly correlated. To calculate your profit, you will subtract your total cost from your sales.

Profit = Sales – Total Cost

We noted earlier that total cost is broken down into two categories; variable costs and fixed costs. 

Total Cost = Variable Cost + Fixed Cost

You can calculate your total variable cost by multiplying the variable cost per unit by the total number of units produced. Depending on your industry, a unit may represent a good or service. 

Total Variable Cost = Variable Cost Per Unit x Number of Units Produced

Let’s use our previous example of an online jeweler: 

Necklaces Raw Materials Shipping Costs Total Variable Costs Fixed Costs Total Costs
0 $0 $0 $0 $250 $250
1 $5 $3 $8 $250 $258
5 $25 $15 $40 $250 $290
10 $50 $30 $80 $250 $330
15 $75 $45 $120 $250 $370
20 $100 $60 $160 $250 $410

 

You will notice that the more necklaces that are made, the higher the variable cost. The jewelry maker’s costs increase and decrease with their production volume.

It costs the jewelry maker $5 in raw materials and $3 to ship one necklace. The jeweler also has fixed costs of $250/month to cover things like web hosting and loan payments.

Last month the jeweler sold 20 necklaces at a rate of $23 per unit, which gave her $460 in sales for the month. 

We can calculate their profit by subtracting their total costs from their sales for the month.

Total Costs: $160 + $250 = $410

Profit: $460 – $410 = $50

Last month, the online jeweler made $50 in profit from their necklace sales. They might be able to increase their profits by finding cheaper materials or finding a way to lower their shipping costs. 

In addition to manipulating their variable costs, they would notice an increase in profit once their loan payment (fixed cost) is paid off. 

Break-even analysis

The break-even point is another number you’ll want to be familiar with. This equates to the number of units that need to be sold in order to cover your total costs.

Let’s assume the jeweler is only selling necklaces. To calculate your break-even point, you will use the following formula:

Fixed Cost / (Unit Sale Price – Unit Variable Cost) = Break-even Point Per Unit

$250 / [$15 ($23 – $8)] = 16.67 or 17 necklaces

The online jeweler must sell a minimum of 17 necklaces to break even on their monthly costs. Once you know this valuable information, you have a goal to strive for to make sure your business is successful.

Recap

To recap, we have variable costs both in our personal lives and in business. Variable costs fluctuate with the volume of activity. The more you consume or create, the higher your variable costs.

In your personal life, variable costs include grocery shopping, car maintenance, and eating out. Examples of variable costs in business might be packaging materials or transaction fees. Variable costs are typically easier to control than fixed costs.

Fixed costs are the opposite of variable costs in that they are the same each month. Examples of your personal fixed costs would be rent/mortgage, health insurance, and car payment. Your fixed business costs could be staff salaries, loan payments, and rent/mortgage as well.

Although fixed costs are sometimes harder to control than variable costs, they can still be manipulated by making lifestyle changes. Such as downgrading to a cheaper car or a smaller building/home.

Budgeting your costs is a key component to being successful. If you track your monthly costs, you will know when it’s time to cut back before it’s too late. Alternatively, you’ll also know when you can splurge a little because the funds are available.  

There are formulas available to help you keep track of total costs, profit, and how many units you need to produce in order to break even. As a startup business, these numbers may be simple enough for you to keep track of, but as your business grows, you’ll likely need to consult with an accountant. 

 

Sources:

https://fasab.gov/accounting-standards/

https://www.ftc.gov/tips-advice/business-center/guidance/electronic-commerce-selling-internationally-guide-businesses

https://templates.office.com/en-us/profit-and-loss

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