Variable Cost – Definition, Formula, and 9 Examples
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Variable costs have proven invaluable to companies in enhancing efficiency and profitability. Grasping the concept of variable costs empowers businesses to conduct more precise cost analyses and make informed decisions to drive success.
In this blog post, we will elucidate the definition of variable costs and offer illustrative examples demonstrating their application. Furthermore, we will delve into the formulas employed to calculate variable costs, equipping readers with practical tools to assess and manage this crucial aspect of their operations.
What is a variable cost?
Variable costs refer to production expenses correlating with a company’s manufacturing activity. One notable example is the cost of raw materials utilized as components in a product. As the number of units produced varies, this expense typically experiences corresponding fluctuations.
The quantity of output directly influences these costs. When production increases, variable costs rise accordingly, whereas a reduction in output leads to fewer expenses. In contrast, fixed costs remain constant regardless of production levels. Consequently, variable costs are considered direct costs linked to production volume, increasing with higher production and decreasing when production levels are lower.
Variable Cost Formula
To determine the total variable costs incurred by a business, it is essential to consider the labour and materials required to manufacture a single product unit or provide a service. The formula for calculating the total variable costs can be defined as the product of the total output quantity and the variable cost per output unit.
Examples of variable cost
Here are examples of variable cost
1. Direct materials
2. Packaging materials
Packaging materials for goods is variable since the quantity utilized can fluctuate by sales and production volume. When production or sales volume decreases, certain companies may reduce the packaging materials utilized for a particular product.
Packaging materials include bags, boxes, twist ties, plastic wrappers, and foil. When evaluating product profitability, many companies consider the cost of packaging materials. By doing so, they can assess the impact of packaging expenses on the overall financial performance of the product.
3. Piece-rate labour
4. Freight out
Businesses bear shipping costs when they sell and distribute products, making freight out a variable cost. These costs arise from transporting raw materials or delivering finished products from one location to another. The mode of transportation can range from land and sea to air.
The amount expended on shipping costs fluctuates by the sales and production volumes of the company. Generally, these costs rise as production and sales volumes increase and decrease when sales and production volumes decrease. The variable nature of shipping costs reflects the dynamic relationship between business activities and the expenses incurred for transporting goods.
4. Production supplies
Production supplies refer to the indirect raw materials required in manufacturing or assembly. A prime instance of production supplies is machine oil, which presents challenges in terms of measurement due to the difficulty in quantifying its usage in machines. As the cost of machine oil fluctuates in correspondence with the production volume, it is classified as a variable cost.
5. Billable wages
Hourly wages represent the remuneration provided to employees based on the number of hours they work. This contrasts salaries, which remain fixed irrespective of the hours employees work.
Billable wages are categorized as a variable cost since they fluctuate about factors such as the number of employees, the hours worked by each employee, and the overall hours permitted by the company or organization. These variables directly impact the total amount expended on wages, highlighting the dynamic nature of billable wages as a cost that adjusts with the changing circumstances of employee work hours.
6. Credit card transaction fees
Transaction fees are charges incurred by businesses that accept credit cards as a customer payment method. In this context, the variable cost pertains to the fluctuating transaction fees incurred each month instead of a fixed monthly fee.
To illustrate, a company may engage a third-party organization to handle processing its credit card sales and compensate them with a percentage of the sales as payment for their services. The variability of transaction fees underscores the unpredictability of the specific amount payable monthly, which hinges on the volume and value of credit card transactions processed.