Businesses live or die based on sales volume and how well they control costs. However, before you can effectively manage expenses and eliminate waste, you have to know what your business is spending and for what. Tracking variable costs is an essential part of this management function. Such costs comprise a major part of overall operating expenses and help determine whether or not a product is profitable.
Variable and Fixed Costs
The expenses a business incurs in the process of conducting its operations can be divided into two categories: fixed and variable costs. The term “fixed costs” refers to expenditures that must be paid even if the business isn’t operating. Examples of fixed costs are rent, insurance payments and compensation for administrative and management staff. Variable costs are expenses tied to producing, acquiring and selling products or services. Unlike fixed costs, which are relatively constant, total variable costs change with the level of production or sales.
Types of Variable Costs
In a retail setting, variable costs may be relatively uncomplicated. For example, a shoe store’s variable costs might only consist of inventory purchased for resale, plus an allowance for lost or damaged items. For a manufacturing enterprise, variable costs typically are more complex. Some common variable expenses are:
- Raw materials
- Wages for production labor
- Inventory financing costs
- Product packaging
- Sales commissions
- Energy costs for production processes
Unit Variable Cost
The formula for calculating unit variable costs is total variable expenses divided by the number of units. Suppose a company produces 50,000 widgets in a year. Variable expenditures might consist of:
- Raw materials..........$350,000
- Production labor......$250,000
- Shipping charges.....$50,000
- Sales commissions..$100,000
Total variable expenses add up to $750,000. Divide total variable expenses of $750,000 by the production quantity of 50,000 widgets and you come up with a variable cost per unit of $15.
Using the Variable Cost Metric
Tracking variable costs is useful for managers who want to document where company money goes, and also is useful for calculating break-even sales volume and for evaluating pricing levels. Break-even sales volume is the number of units a firm must sell to exactly cover total operating costs. Suppose a firm sells widgets for $40. The variable cost per unit equals $15. Fixed costs are equal to $700,000 for a year. Subtract the variable cost per unit of $15 from the $40 price, leaving $25. Divide fixed costs by $25 and you have a breakeven sales volume of 28,000 units. If the company doesn’t expect to sell enough additional units to provide an adequate profit, management will want to re-evaluate the pricing strategy, company sales goals or both.
- Photo Credit Digital Vision./Photodisc/Getty Images
How to Determine Variable Selling & Administrative Costs
Variable selling and administrative costs are critical components in both variable and absorption accounting calculations. Variable costs such as commissions, bonuses and...
How to Calculate a Break-Even Point in Units
Calculating a break-even point in business determines the point during a specific period of time at which a company shows neither profit...
How to Calculate Cost Per Unit
Total cost consists of fixed and variable costs. Fixed costs do not change based on production. Examples of fixed costs include rent,...
How to Calculate Overhead Cost Per Unit
Pricing is one of the most important factors in competition. Those companies with a better business model have an automatic advantage over...
How to Find Variable Cost Per Unit Using High-Low Method
In order to get goods and products ready for sale, a business incurs both fixed costs and variable costs. If a company...
How to Calculate Total Cost in Economics
Examining the components of the total cost of production is an important activity for any business owner or manager. Total cost for...
How to Calculate Variable Cost
There are two main cost categories: variable and fixed. A variable cost is one that changes with your level of output. An...
How to Calculate Fixed & Variable Costs
An article that distinguishes fixed, variable and mixed costs and provides example calculations for each.
How to Calculate Unit Product Cost
An article that explains how to compute unit product costs under financial accounting and managerial accounting.
How to Calculate Product Cost Per Unit
Product cost per unit is a figure used by businesses to determine the actual cost of a single unit of product. Product...
How to Calculate Fixed Cost Per Unit
Fixed costs are manufacturing costs that do not change with the volume of production for a company. For example, if your fixed...
How to Calculate Variable Manufacturing Overhead
Variable manufacturing overhead costs are a set of expenses that fluctuate as production levels change. Businesses calculate and use variable manufacturing overhead...
How to Calculate for a Cost Function
A cost function is an economic function used in manufacturing to aid in making production line decisions. The cost function covers the...
What Is the Difference Between Fixed and Variable Cost?
Fixed and variable costs relate to both business and personal finance. Although they lie at opposite ends of the spectrum, they both...
What Is a Variable Unit Cost?
A variable unit cost is an expense that varies directly with the production of one additional unit. In budgeting, variable unit costs...