How To Find Variable Cost: Examples, Formula, and Guide To Calculate It
The majority of business failures are linked to financial issues. Most companies fold because it’s no longer possible to balance the books. Accounting plays a crucial role in keeping businesses afloat and providing warning lights for business owners. To reduce the risk of problems and maximize profits, entrepreneurs and company directors must be aware of the costs involved in running a business and the margins required to stay in the black.
In this informative guide, we’ll explore the concept of variable costs and explain why they’re so important when managing accounts and making decisions.
What Are Variable Costs?
Variable costs relate to the costs involved in creating products. The variable cost is a sum that reflects all the materials, labor, and parts required to create a unit of the product your business sells. These costs are called “variable” because, unlike fixed costs, they directly depend on the number of units you produce.
The term variable cost per unit is used to describe every cost required to create a single unit of the product you produce.
The total variable cost, on the other hand, is a sum that covers all the variable costs involved in developing one unit multiplied by the number of products. To calculate the total variable cost, therefore, you’ll need to multiply the variable cost per unit by the number of units. If your variable cost per unit is $50, and you produce 10 units, your total variable cost will be $500.
If, for various reasons, not all units cost the same to produce, you’ll benefit from learning how to find the average variable cost using a variable cost formula:
Average variable cost = Total variable cost / Number of units
In cases where you need to calculate the average variable cost of different products, you can use the following formula:
Average variable cost = (Total variable cost product A + Total variable cost product B) / Total number of units
It’s often beneficial for business owners to look at the total variable cost vs. the average variable cost. Using a variable cost calculator enables you to analyze and monitor costs, including the variable cost per unit produced and sold. It’s crucial for businesses to be able to control spending and manage expenses to maximize the chances of making a profit and improve efficiency.
Variable Costs vs. Fixed Costs
Unlike variable costs, fixed costs don’t change, regardless of how many units you produce.
Examples of fixed costs include:
- Some utility bills
- Renting business premises
- Business loan repayments
- Taxes on premises
- Licenses and permits
- Vehicle leasing
It’s important to understand that fixed costs are not always static. For example, it’s possible for rental fees to increase or for energy prices to rise. Fixed costs are fixed in terms of their relation to production and manufacturing. They will remain the same if production increases or falls. In contrast, variable costs will rise or fall in line with production. If the company grows and the number of units produced increases, variable costs will rise. If the business scales operations back, variable costs will decrease.
Just as you can calculate the average variable cost, you can also work out the average fixed cost. You can use the average fixed cost formula by dividing the total fixed costs by the number of units produced during a specific period. To make the calculation, you’ll need to follow these steps:
- Determine the period you want to evaluate
- Add all of your fixed costs to obtain a total fixed cost
- Calculate the number of units produced in that period
- Divide the total cost by the number of units
Examples of Variable Costs
Every business will encounter fixed and variable costs when manufacturing and selling products. Some common examples of variable costs include:
- Physical materials and supplies
- Sales commission
- Wages and salaries
- Processing and credit card fees
- Online payment fees
- Packaging and shipping charges
What Is the Variable Cost Ratio?
Calculating the variable cost ratio enables business owners to determine how their variable costs impact net sales. As a business grows and order numbers increase, production increases, which drives variable costs up. To facilitate healthy expansion, it’s beneficial for businesses to monitor the variable cost ratio, which is calculated using this formula:
Variable cost ratio = Variable costs / Net sales
Let’s take a look at an example. If you sell a product at a price of $100, and it costs $20 to produce, you divide $20 by $100 and then multiply the figure by 100. This means that in this example, the variable cost ratio would be 20%. In this case, 20% of the sale price goes to variable costs, and your return is 80%.
Using variable and fixed costs can also enable you to figure out the point at which you break even and start making a profit. In the example above, you would add your fixed costs to the variable costs of $20. If the fixed costs were also $20 per unit, this would give you a total of $40 for fixed and variable costs, meaning that your return on each unit would be $60.
The higher the total cost ratio, the lower the chance of generating profits. If your cost ratio is negative, you’ll be losing money. To boost profits, it’s a good idea to analyze costs and see if you can reduce expenses. You may be able to do this by negotiating a better deal on materials, shipping or transaction fees, or switching to a different material, which is cheaper to buy, for example.
Fixed and variable costs are costs that businesses incur to make and sell products. Fixed costs stay the same regardless of the level of production. Variable costs change according to whether the number of units produced rises or falls. To find variable cost, you can use a variable cost calculator or this variable cost formula: Total variable cost = Cost per unit x Total number of units. To work out your total fixed costs, you’ll need to add up all your fixed costs.
Examples of variable costs for businesses include materials and supplies, credit card and transaction fees, sales commission and shipping, handling and packaging fees. Every business that manufactures and sells products will need to cover fixed and variable costs. Fixed costs do not change if production increases or decreases. Variable costs will rise and fall in line with production.
The variable cost per unit covers all the variable costs incurred to produce a single unit. The variable cost per unit formula is as follows: Total variable expenses / Number of units.
Julia A. is a writer at SmallBizGenius.net. With experience in both finance and marketing industries, she enjoys staying up to date with the current economic affairs and writing opinion pieces on the state of small businesses in America. As an avid reader, she spends most of her time poring over history books, fantasy novels, and old classics. Tech, finance, and marketing are her passions, and she’s a frequent contributor at various small business blogs.
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