How to Calculate the Variable Cost for a Business Plan
If you are putting together a business plan, it is important to understand the relationship between fixed and variable costs. It is also important to understand how these costs drive funding needs because this will be a consideration for any lender and a question that will be asked before funds are granted for your business. The first step in the process is to understand how to calculate variable costs.
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Instructions
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Define variable costs. The hardest part about calculating variable costs is determining which costs are variable costs. Variable costs vary directly with revenues. That is, the more that's being produced, the higher variable costs will be. Let this be the test for determining which costs should be included in variable costs.
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Determine variable costs. One of the largest variable costs is labor. Another is cost of goods sold (CGS), which includes all inventory. Travel is another cost that is often directly related to sales.
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Let's walk through an example. Let's say that you produce 10,000 ice picks. The factory overhead is $3,000 a year. Other costs are materials at $2 per pick and labor at $5 per pick.
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Calculate total variable costs. Add all costs that vary with ice pick production. This includes materials and labor. The total variable cost is $7 per pick. The total cost of the 10,000 ice picks is $3,000 (fixed overhead) + $70,000 ($7 x 10,000) = $73,000. Higher variable costs provide management with a more flexible cost structure that can respond faster to changes in demand.
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