Variable Cost Definition and Meaning

However, other costs can vary significantly as your business grows. Let’s say you’re paying $100 for web hosting each month, but one month you exceed your bandwidth limit and are hit with an extra $20 fee. You’ll pay the fixed $100 no matter what, but the extra $20 is variable.

This often includes cutting back on large fixed costs, but it can also entail streamlining variable costs. A variable expense is a cost that changes depending on your production level. In other words, your sales volume directly impacts your variable expenses. On the other hand, some variable expenses are much easier to adjust in a pinch.

Types of variable costs

For example, a European carmaker may have to import steel from China and pay in Yuan. Volatility in the exchange rate could drive steel prices higher when converted into Euros, and this, in turn, would increase the variable cost. The break-even analysis is an excellent way to understand the dynamics of fixed and variable costs and the sales level required to cover these. So, the higher the variable cost per unit, the lower the Gross Profit, reducing the operating margin and profitability margin. In other words, the profit margin is indirectly related to variable costs.

• How you approach saving money can vary, based on whether you’re trying to cut your fixed or variable expenses.
• Take your learning and productivity to the next level with our Premium Templates.
• Consider the variable cost of a project that has been worked on for years.
• They denote the amount of money spent on the production of a product or service and are among the most important analyses a business (or consultant) can run.
• As mentioned above, variable expenses do not remain constant when production levels change.
• For each handbag, wallet, etc. that Coach produces, it incurs a variable cost.

Saving money in either category is possible, but the process for each can differ. Knowing how costs behave when sales or other activities change will allow you to better understand how a company’s gross profit and net income will change. It also allows you to quickly calculate a product’s contribution margin and to estimate the company’s https://adprun.net/how-much-should-i-charge-for-bookkeeping-services/ break-even point. Budgeting for variable expenses can be more challenging, as you may not be able to pinpoint exactly how much they’ll add up to from one month to another. If you’re not tracking variable expenses regularly, it could be very easy to under- or overestimate how much of your budget you should allocate to them.

Variable vs Fixed Costs in Decision-Making

A variable expense, on the other hand, may change due to a variety of factors, which means you can’t always predict exactly what it will cost. The amount of materials and labor that goes into each shirt increases with the number of shirts produced. In the long run, if the business planned to make 0 shirts, it would choose to have 0 machines and 0 rooms, but in the short run, even if it produces no shirts it has incurred those costs. If the revenue that they are receiving is greater than their variable cost but less than their total cost, they will continue to operate while accruing an economic loss. If their total cost is less than their variable cost in the short run, the business should shut down. If revenue is greater than their total cost, this firm will have positive economic profit.

While the packaging cost per case remains the same, the total cost of packaging rises when production is higher. From month to month, you probably know how much you spend on fixed expenses because these don’t change often. Some variable expenses can be more easily controlled than others.

Importance of variable cost to business

Examples of variable costs are sales commissions, direct labor costs, cost of raw materials used in production, and utility costs. In an international business, consolidating variable and fixed costs can be a difficult task. Sales and costs can be incurred in multiple 8 Best Accounting Software for the Self-Employed in 2023 currencies as companies source and sell across different countries. While expanding globally allows businesses to access foreign markets, it poses a new set of challenges. The above example has explained variable cost, but what about the company’s fixed costs?

Marginal cost refers to how much it costs to produce one additional unit. The marginal cost will take into account the total cost of production, including both fixed and variable costs. Since fixed costs are static, however, the weight of fixed costs will decline as production scales up. A company can increase its profits by decreasing its total costs. Since fixed costs are more challenging to bring down (for example, reducing rent may entail the company moving to a cheaper location), most businesses seek to reduce their variable costs.

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For example, Amy is quite concerned about her bakery as the revenue generated from sales are below the total costs of running the bakery. Amy asks for your opinion on whether she should close down the business or not. Additionally, she’s already committed to paying for one year of rent, electricity, and employee salaries. A pet sitting business has to travel to visit clients and the price of gas for the company vehicle is a variable cost, as is the number of miles traveled. Her business cell phone is pay-as-you-go and so is a variable expense.