What is Variable Cost?

Every commercial business has various types of expenses resulting from different types of activities. Whenever the manufacturing activity undergoes changes, the cost for those activities also changes. These are known as variable costs, and they keep varying in accordance with the varying activities of the manufacturing processes. Variable costs increase when a business enterprise experiences a high volume of sales. They decrease when the production activity is less due to fewer sales. There are many situations where a business is forced to manufacture one specific unit. In such cases, the machine and processing expenses are not considered again, but the extra materials, additional processing as well as direct labour have to be factored in. This type of pricing system helps to create prices that add a markup to the total variable expenses for creating that one distinct unit. The markup amount is of a slightly high percentage so that the said business is able to make a fair amount of profit.

Did you know?

You can adjust the variable costs of your manufacturing activities in accordance with the increase or decrease in sales.

What is a Variable Cost?

A variable cost is also known as a periodic cost. It keeps changing in accordance with the product output of an organisation. An optimal production output increases the variable cost, and a declining production level reduces a variable cost. Some of the most typical variable costs in a commercial business include:

• The various materials that are involved in the making of the product – this involves all the materials used in the manufacture of the final products. For example, all tangible ingredients like fabric for making clothes, specific glue for footwear, circuit boards in assembling computers or even steel in construction.
• The different supplies used in the packaging process. Some of these supplies include packing boxes, bags, foil as well as plastic wrappers. These supplies differ according to the different manufacturing processes of a wide range of products across different industries.
• Labour – This includes expenses incurred on a piece-rate basis (payments made to labour based on the no. of units which are manufactured and not on the time involved in that activity)
• Transport costs – The delivery of raw materials from the source to the manufacturing unit and delivery of finished goods to clients.
• Supplies used in the production process – This includes machines and miscellaneous tools.
• Daily wages – This includes the wages paid to staff on the basis of the number of hours worked.
• Transaction expenses for the usage of credit cards by customers while paying for the products.

Also Read: Know How To Calculate Cost of Capital With Examples

How to Compute a Variable Cost Formula?

A variable cost formula is indispensable to every business that likes to understand its variable expenses. Every business has to determine:

• The cost involved in the manufacturing of a single unit,
• The quantity produced
• The time frame for determining the variable cost.

The formula is as follows:

The total variable cost = the total quantity produced x the variable cost for every unit that is produced

Difference Between Fixed Cost and Variable Cost

The manner in which these costs are named makes them self-explanatory. Fixed costs are not impacted by any changes in the manufacturing process. Businesses experience a high volume of sales during festive seasons and fewer sales during off-season times of the year, but the fixed costs of production remain the same. These are not costs that are involved in the production process but are costs that have to be incurred for the manufacturing process irrespective of the quantities and demand, among other factors. Variable costs change in accordance with the volume of production. A high volume of production increases the variable costs. They decrease when the manufacturing process is experiencing a slow-down because of fewer sales.

Given below are some examples of fixed costs:

• Money paid as rent for occupying premises
• Money paid towards insurance
• Payments made towards storage of products
• Expenses incurred for renting various types of equipment
• Depreciation calculated on the existing assets

Total Cost:

This is very simple to understand. It is a sum of the total variable and total fixed cost.

Total Cost = Total variable costs + total fixed costs

What Is the Variable Cost Ratio?

The variable cost ratio enables a commercial enterprise to strive for a maximum balance between the increase in returns and the expense due to an increase in production. It is a cost accounting tool.

The ratio is calculated by dividing the variable costs by the total net sales, i.e.

Total variable expenses / Total Net Sales, or dividing the variable expense of each unit by the price per unit.

Let’s consider an example to understand this better.

A cricket manufacturing unit makes a sale of 10,000 in a year.

Cost of each cricket bat is ₹200.

The variable cost of each bat is ₹150.

Variable cost ratio = ₹150 / ₹200 = 75%.

The contribution margin is the difference between the total amount of revenues and the total variable costs involved in the production of goods sold. The contribution margin assists a business in the calculation of its break-even point.

Examples of variable costs

Given below are some variable cost examples:

Example 1.

A baker specialises in making a distinct variety of cupcakes. Suppose the number of cupcakes made by the baker varies. Let us understand how the variable costs get impacted.

The above table clearly indicates how the variable costs increase when the production of cupcakes increases. In the absence of production, variable costs are also absent.

Example 2.

Now let us take some simple examples of variable costs:

A corporate business is organising its annual anniversary event and invites its key clientele.

Some of its fixed costs will include:

• The location of the event
• Requirement of a podium and stage
• Stage artists and performers
• Event organisers and their crew members
• Modes of lighting
• Payment towards photographer and videographer
• Invitations (including an RSVP)

 The variable costs for the event will include:

• Snacks and drinking water
• Drinks – soft drinks and liquor
• Transport facilities for guests, if required
• Printing of event menu
• Souvenirs

Also Read: Calculating Break-Even Point – Analysis, Definition, and Formula with Examples

 Semi variable costs:

• A semi-variable cost will include – additional staff to attend to the guests, and their requirements
• Other semi-variable costs – Event license and Insurance fees which require a specific sum of money

Fixed costs for a restaurant include:

• Amount of rent paid on a monthly, quarterly or annual basis
• Payments towards loans taken
• Payment towards permits with regards to health as well as zoning. The health permit validates that your business is in abidance with all the health regulations of the health department. The zoning permit states that your restaurant business is in compliance with the rules laid by the said zoning ordinances.
• All fixed, variable as well as semi-variable costs vary in accordance to the functions of different organisations
• Variable costs for a restaurant include:

Daily provisions of raw materials – vegetables, white and red variety of meat, and spices among others.

Crockery breakages – this could also include breakages of delicate wall hangings among other items.

Daily marketing

Semi variable costs include:

• Payments for staff employed on an hourly basis (e.g. college students)
• Lighting and supply of clean water
• Maintenance of books of accounts

Fixed costs for an e-commerce business include:

• Payment towards rent of premises
• Regular fees for hosting the website
• Payment towards high-speed internet
• Payment towards utilities

Variable costs for an e-commerce business include:

• Dispatching and shipping of products
• Payments to Suppliers of goods
• Advertising costs to promote the business on social media platforms
• Payments made to influencers
• Expenses towards personnel like web designers

Semi-variable costs for e-commerce include:

• Payment towards advertising – Pay per click
• Payments made towards fulfilment of deliveries

Conclusion

This article attempts to explain variable costs and how they vary according to the production processes. These details also showcase how different industries experience different variable costs. You also get an insight into how you can calculate the variable cost ratio. You need to understand the difference between fixed and variable costs because every business has to incur fixed costs irrespective of its active or inactive manufacturing processes. 
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