Variable Costs

Updated on April 5, 2024

Variable Costs Definition

Variable costs are expenses that do not remain constant. Instead, they vary with time and production levels. Variable expenses are directly proportional to production quantity.  It is the opposite of fixed costs, which remain constant irrespective of production levels. An ideal variable costs equation should neither be too high nor too low to ensure a smooth flow of operations.

Variable Cost

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Firms rely on variable cost accounting to determine fluctuations and to control cost per unit. For example, when a firm starts a new project, they try to project future expenses. This is known as the average variable expense of the project. In addition, raw materials, production costs, delivery costs, packaging, and labor tariffs are variable expenses.

Key Takeaways

  • Variable costs are expenses that do not remain constant; they vary with time and are directly affected by the production process.
  • A business incurs fixed and variable expenses by continuing day-to-day business operations.
  • Semi-variable expense is the aggregation of expenses incurred by a business, where some components are fixed costs and others are variable costs. Here, costs are fixed to a specific production level. However, manufacturers incur variable expenses if they increase production beyond that level.

Variable Costs Explained

Variable costs are expenses that fluctuate proportionally with the level of production or business activity. These costs vary as production volumes change and are directly linked to the quantity of goods or services produced. Examples of variable costs include raw materials, direct labor, and utilities directly associated with production. Variable costs increase or decrease with the level of output, making them dynamic and responsive to changes in business operations.

Variable costs refer to expenses that fluctuate over time. Businesses incur both variable costs and fixed costs. A fixed cost does not change with time. In contrast, variable expenses are not fixed (they vary over time).

Variable expenses calculators are based on business operations —internal factors and external factors. Variable expenses include raw materials, production costs, delivery costs, packaging, and labor tariffs.

A business cannot always predict expenses. Thus, when a firm starts a new project, it tries to gauge a ballpark figure of its future expenses. This is known as the average variable expense of the project.

There is a linear relationship between variable expenses and production. Fixed costs are often seen as unavoidable—employee salaries, electricity, rent, and office expenses. Variable expenses, on the other hand, are often seen as discretionary. Maintenance costs are a good example; maintenance is essential but can be delayed if there’s a cash crunch. The same cannot be said of employee wages.

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Formula

To use a variable cost calculator, we apply the following formula-

Average Variable Cost Formula

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Variable costs = Cost per unit x Total number of units

After calculating variable expenses, it is applied to conduct a break-even analysis of a firm.

Break-even analysis = Fixed costs/Selling price per unit – Variable cost per unit

How To Calculate?

Calculating a variable costs equation involves a detailed analysis of costs directly associated with production, ensuring accurate assessments for pricing, budgeting, and decision-making processes. Let us understand the step-by-step process through the points below.

  • Identify costs directly tied to the production of each unit, such as raw materials and direct labor.
  • Calculate the cost per unit for each direct variable cost by dividing the total cost by the number of units produced.
  • Sum the individual variable costs to get the total variable cost for a specific production volume.
  • If needed, apply the high-low method by comparing costs at the highest and lowest production levels to determine the variable cost per unit and the fixed cost component.
  • Include variable overhead costs, such as utilities or direct production-related expenses, which vary with production levels.
  • As production volumes change, regularly update variable cost calculations to reflect the dynamic nature of these costs.

Types

Let us understand the different types that are applied through variable costs calculators from the discussion below.

#1 – Material Costs

Raw materials are an indispensable component of production. Thus, businesses have to order, purchase, and maintain a stock of raw materials. Further, this Inventory is stored in warehouses and factories. Finally, raw materials are used to make finished goods.

However, the actual quantity of required raw material varies. If firms lack operating capital, they can survive with less inventory. It also depends on the demand for the product. When demand is high, production runs at total capacity. When demand is low, production is curtailed. Thus, raw material is considered a variable expense.

#2 – Labor and Workforce 

Every production unit employs a workforce; the workers are compensated using varying remuneration structures. Some are hired hourly; others have a fixed salary—paid at the end of the month. Some receive minimum wages others receive substantial amounts.

Sometimes, there is a sudden fall in the availability of labor—production cannot be stopped—wages hike overnight. Employee wages are related to various direct and indirect factors. Thus, it is considered a variable expense for the firm.

#3 – Associated charges, Fees, and Commissions

From manufacturing to selling the product, business operations are divided into multiple stages. Even when a business fails to make a single sale, it still incurs certain liabilities in the form of associated costs, fees, and commissions.

Similarly, a business offers discounts, sales commissions, and hidden fees to agents and distributors. These expenses fluctuate all the time and are hard to predict. Thus, commissions are considered a variable expense.

#4 – Transportation costs

Transportation costs affect all the stages of the supply chain. Transportation costs depend on location, packaging, and logistics. Transportation costs include the cost of freight, carriage, shipping, transit insurance, cost of operating the fleet, etc.

Businesses have very little control over transportation. It depends on the weather, fuel charges, infrastructure, and conditions. Moreover, the particular government is in charge of infrastructure. Thus transportation costs keep varying.

Examples

Now that we understand the basics, formula, and how to calculate variable costs equation, let us also explore the practical application through the examples below.

Example #1

In the variable expense equation, the variable expense is a dependent variable—internal and external factors are independent variables. Here, internal and external factors refer to components like production scale, workforce, socio-political environment, etc.

Let’s look at a variable cost example to understand the calculation.

Let us assume that a company that manufactures 900 linen shirts daily. To achieve this, the company appoints 45 laborers and pays each laborer $18 for a day’s work.

To calculate variable expenses for 30 days, we apply the given values to the formula:

  • Variable Costs = Cost per unit x Total number of units
  • Variable Costs = 45 x 18 x 30 = $24300

After two months, there was a labor crisis in the city; the labor union went on strike against a new policy introduced by the government. As a result, fewer laborers were available—demand for labor rose—labor wages elevated overnight.

To complete production, the manufacturer is forced to pay each worker: $40 for a day’s work. That is twice the standard rates. But first, let us compute the total expense.

  • Variable Expense = 40 x 45 x 30
  • Variable Expense = $54000

The difference between the costs of production between the two months –

  • 54000 – 24300 = $29700

Thus, external factors caused a $29700 change in variable expense for other months (despite outputting the same production levels).

Example #2

The Electric Vehicle (EV) revolution has been on a rise since 2021-2022. Major automobile manufacturers have been hustling towards coming up with a car with the highest ranges, quickest charging speed, and so on.

Amidst the tight competition, the CEO of Mercedes Benz, Ola Kaellenius said that the variable costs for producing EVs would be higher than manufacturing conventional cars for the foreseeable future.

He also mentioned the CLA variant of their cars are set to reduce costs by roughly 50% for the consumers with regard to fuelling.

How To Reduce?

Reducing variable costs involves a combination of strategic sourcing, process optimization, and other such strategies. Let us understand how to reduce the value on a variable costs calculator through the discussion below.

  • Negotiate with suppliers to secure better terms, discounts, or bulk purchase arrangements for raw materials.
  • Streamline production processes to reduce waste, minimize downtime, and enhance overall operational efficiency.
  • Cross-train employees to perform multiple roles, optimizing workforce flexibility and reducing the need for overtime or additional labor.
  • Implement technology and automation to improve production speed, accuracy, and reduce labor costs.
  • Adopt energy-efficient practices and equipment to lower utility costs associated with production.
  • Periodically review and evaluate alternative suppliers to ensure the best pricing and terms for materials.
  • Regularly monitor and analyze variable costs, seeking ongoing opportunities for cost reduction and efficiency improvement.

Importance

Understanding and managing variable costs equations are integral to financial planning, strategic decision-making. Let us understand how through the explanation below.

  • Variable costs play a crucial role in determining the direct costs associated with producing each unit, guiding pricing strategies to ensure profitability.
  • Understanding variable costs allows businesses to assess the profitability of products or services by comparing revenues to variable expenses.
  • Variable costs are integral to break-even analysis, helping identify the point at which total revenues cover both variable and fixed costs.
  • Variable costs are essential for accurate budgeting and forecasting, enabling businesses to project costs based on expected production levels.
  • Monitoring variable costs provides insights into operational efficiency, helping identify areas for improvement and cost reduction.

Variable Costs Vs Fixed Costs

Let us understand the distinctions between variable and fixed costs through the comparison below.

Variable Costs

  • Vary proportionally with production or business activity levels.
  • Directly linked to the production of each unit or service, changing as production volumes change.
  • Raw materials, direct labor, variable portion of utilities.
  • Variable costs are dynamic and responsive to changes.

Fixed Costs

  • Remain constant regardless of production or business activity levels.
  • Unaffected by changes in production volumes, representing ongoing operational expenses.
  • Rent, salaries of permanent staff, insurance.
  • Fixed costs provide stability but may pose challenges during low production periods.

Frequently Asked Questions (FAQs)

1. How to calculate the total variable cost?

It is determined by dividing the cost per unit by the number of units. It is an aggregation of various variable expenses incurred by a business.

2. What are semi-variable costs?

Semi-variable expense is also called mixed cost. It is the aggregation of expenses incurred by a business, where some components are fixed costs and others are variable expenses. Usually, this is witnessed in mass production—costs are fixed to a specific production level. However, manufacturers incur variable expenses if they increase production beyond that level.

3. What is the difference between variable costs and fixed costs?

Fixed costs include employee salaries, office rent, electricity bills, etc. These expenses are indispensable (irrespective of production levels). Variable expense, on the other hand, depends on production levels. Variable expenses include raw materials, production costs, delivery costs, packaging, and labor tariffs.

This article has been a guide to what are Variable Costs and its definition. Here, we explain its types, formula, calculation, and example. You can learn more about it from the following articles –

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