What is a variable cost: examples and formula

Raw materials are the direct goods purchased that are eventually turned into a final product. If the athletic brand doesn’t make the shoes, it won’t incur the cost of leather, synthetic mesh, canvas, or other raw materials. In general, a company should spend roughly the same amount on raw materials for every unit produced assuming no major differences in manufacturing one unit versus another.

Some companies aim to increase revenue by doubling their output in the next financial year. Knowing the current variable cost using a variable cost analysis will determine whether any strategic plans for growth, contraction, or expansion are feasible. Variable costs are important when determining a specific product’s contribution margin and are used to calculate your company’s profit.

Contribution Margin

The first step in analyzing mixed costs with the high-low method is to identify the periods with the highest and lowest levels of activity. We always choose the highest and lowest activity and the costs that correspond with those levels of activity, even if they are not the highest and lowest costs. In March, Waymaker produced 1,000 units and used 2,000 hours of production labor.

The good news is there are powerful tools, like Katana, that were created to help manufacturers and the accountants that serve them calculate variable costs correctly. Watch this short video to quickly understand the main concepts covered in this guide, including what variable costs are, the common types of variable costs, the formula, and break-even analysis. As the global focus on sustainability intensifies, companies will increasingly integrate eco-friendly practices into their variable cost management strategies.

Tips to Effectively Manage Variable Costs for Small Businesses

Lean management focuses on eliminating waste in all forms from the production process. Variable costs can guide businesses in determining how to allocate resources optimally. Sales commissions, for example, are also considered variable because the size of a commission is tied to the volume of products sold by an employee. Changing from the traditional allocation method to ABC costing is not as simple as having management dictate that employees follow the new system. There are often challenges that begin with convincing employees that it will provide benefits and that they should buy into the new system.

Variable cost changes with the total output; hence the marginal cost is also a part of the total output. Marginal costs may include variable costs as they are also a part of the company’s total production. Fixed costs stay the same, regardless of how much or how little a business produces. On the other hand, variable costs rise and fall depending on the volume of production.

Case Study 1- Manufacturing Industry

Learn how to calculate variable cost and gain valuable insights into your business’s profitability. For instance, sudden spikes in raw material prices or unforeseen changes in labor costs can significantly impact the variable costs of a business, affecting profitability. In any case, the variable direct costs and fixed direct costs are subtracted which group of costs is the most accurate example of variable cost? from revenue to arrive at the gross profit. In general, companies with a high proportion of variable costs relative to fixed costs are considered to be less volatile, as their profits are more dependent on the success of their sales. Variable costs are expenses that vary in proportion to the volume of goods or services that a business produces.

Fixed costs are simply added together to get a company’s total fixed costs. A variable cost analysis will help a company ensure how much it should price a product in order to earn profits from that sale. The absorption costing method is typically the standard for most companies with COGS. Auditors and financial stakeholders will require it for external reporting. Depending on the type of business structure, small businesses may also be required to use absorption costing for their tax reporting.