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A Complete Guide On How To Find Variable Cost
In This Blog, We Will Learn How to Find Variable Costs, How to Calculate Them, Types of Variable Costs, and Differences from Fixed Costs for Informed Financial Management.
Published on 16 Aug 2023
Table of Contents
When it comes to managing your business finances, understanding variable costs is essential. In this complete guide, we will explore what variable costs are, how to find variable cost, how to calculate them using the variable cost formula, the different types of variable costs, and how they differ from fixed costs. By the end of this guide, you will have a clear understanding of variable costs and be equipped with the knowledge to make informed financial decisions for your business.
What is a Variable Cost?
A variable cost is an expense that changes in direct proportion to the level of production or sales. Unlike fixed costs, which remain constant regardless of production levels, variable costs fluctuate as the volume of production or sales increases or decreases. In simple terms, variable costs increase when production increases and decrease when production decreases.
To give you a better understanding, let’s consider an example. Imagine you own a bakery, and your variable cost is the cost of ingredients used to make your baked goods. As you produce more pastries, the cost of ingredients will increase. On the other hand, if you have a slow day and produce fewer pastries, the cost of ingredients will decrease accordingly. This is why variable costs are often referred to as “costs of goods sold” or “direct costs.”
The Variable Cost Formula and How to Calculate It
Now that we have a basic understanding of what variable costs are, let’s dive into the variable cost formula. The formula for calculating variable costs is relatively straightforward:
Variable Cost = Total Cost of Production – Fixed Costs
To calculate the variable cost, you need to subtract the fixed costs, which are the expenses that remain constant regardless of production levels, from the total cost of production. The result will give you the variable cost.
For instance, let’s say your bakery’s total cost of production for a month is $10,000, and your fixed costs amount to $4,000. By subtracting the fixed costs from the total cost of production ($10,000 – $4,000), you will find that your variable costs for the month are $6,000.
Types of Variable Costs
Variable costs can vary across different industries and businesses. Here are some common types of variable costs you may encounter:
- Direct Materials: These are the raw materials or components used in the production process. Examples include the flour, sugar, and butter used in baking or the fabric used in clothing manufacturing.
- Direct Labor: This refers to the wages or salaries paid to workers directly involved in the production process. For example, the wages of bakers in a bakery or assembly line workers in a manufacturing plant.
- Variable Overhead: Variable overhead costs include expenses that fluctuate based on production levels but are not directly tied to materials or labour. This could include electricity costs, packaging materials, or shipping expenses.
- Sales Commissions: If your business operates on a commission-based sales model, the commissions paid to sales representatives would be considered variable costs. These costs increase as sales volume increases.
It’s important to identify and track the different types of variable costs specific to your business to have a clear understanding of your cost structure and make strategic decisions.
Variable Costs vs. Fixed Costs
Differentiating between variable costs and fixed costs is crucial for effective financial management. While variable costs change with production levels, fixed costs remain constant over a certain period, regardless of production or sales volume. Here are some key differences between the two:
- Nature: Variable costs are directly tied to production or sales volume, whereas fixed costs are incurred regardless of the level of production or sales.
- Fluctuation: Variable costs fluctuate in direct proportion to production or sales changes, while fixed costs remain unchanged.
- Impact on Profitability: As variable costs increase, they directly impact the profitability of each unit produced or sold. On the other hand, fixed costs have a more indirect impact on profitability, as they are spread over a larger number of units.
Understanding the difference between variable costs and fixed costs is essential for budgeting, pricing decisions, and overall financial planning.
In conclusion, variable costs are an integral part of managing your business finances. By understanding what variable costs are, how to find variable cost, how to calculate them using the variable cost formula, the different types of variable costs, and their distinction from fixed costs, you will be better equipped to make informed financial decisions. Remember to track and analyze your variable costs regularly to gain insights into your cost structure and optimize your business operations. By effectively managing your variable costs, you can improve profitability and drive business growth.
Now that you have a comprehensive understanding of variable costs, it’s time to apply this knowledge to your own business. Evaluate your cost structure, identify the different types of variable costs, and leverage this information to make strategic financial decisions. By doing so, you’ll be one step closer to achieving financial success and sustainability for your business.
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