Sooner or later, all growing businesses face the problem of rising production costs. The more successful your business is, the more the demand for its products or services grows, and expenses follow. Unfortunately, the cost of producing more doesn’t have to scale proportionally to your profits.
The more sales you make, the more you have to invest back into the business. This includes marketing, raw materials, labor, and investing in new products and prospects. Knowing how to find the variable cost is essential for businesses that want to grow without being overwhelmed by the demands of upscaling production.
A variable cost is an expense that directly depends on how much of a specific product your enterprise manufactures or sells. These costs directly depend on the volume of goods. With increased demand, there are more expenses, and with a reduced trading volume, the expenses are lowered.
The number of raw materials needed for production can vary depending on the number of orders your business receives. Furthermore, the price of materials can also fluctuate with market changes. With more goods, you need more packaging, online sales incur more transaction fees, and you need additional labor to meet the demand.
Variable cost, by definition, is the total sum of materials and labor needed to manufacture a unit of product.
Variable Cost per Unit = Materials + Labor
Your supplier may change the price of the material, or the labor market may force you to adjust the wages. That’s why the cost of making your product isn’t a fixed value and will likely change over time.
The total variable cost is equal to the sum of all costs per unit, for all units.
Total Variable Cost = Variable Cost Unit 1 + Variable Cost Unit 2 + … + Variable Cost Unit N
The total value of creating a series of products is represented in the equation above, and it’s the sum of each individual product manufactured, where N equals the total number of units.
You can multiply the cost of a single product you manufacture by the total number of units you plan to produce to get an approximate value for the total variable cost. If the expenditure per product doesn’t vary as much, you can calculate the total variable cost as a multiplication of the value per unit and the number of units.
Total Variable Costs = Variable Cost per Unit x Number of Units
The total variable cost formula isn’t as precise as the total sum of all costs. However, it can be less time-consuming and easier to calculate since it doesn’t involve keeping expense records of each product your business produces.
If there are bigger cost variables between products you manufacture, then you should calculate average variable costs. This value will help make ballpark calculations of how much funds you need to put aside to fulfill an order that requires a certain number of units to produce.
Average Variable Cost = (Variable Cost Unit 1 + Variable Cost Unit 2 + … + Variable Cost Unit N) / Total Number of Units
These are the most common types of expenses you can expect for your small business:
These are just some of the examples of variable costs you can expect. Some unforeseen expenses can always pop up and disrupt your monthly bottom line. That’s why having business insurance helps, even though it adds to fixed monthly expenses.
Unlike variable costs, fixed expenses don’t depend on the growth of your trading volume. These are recurring charges like interest payments, rent, insurance, utilities, website hosting, etc. Depending on the type of business, an expense may be seen as a fixed cost of doing business.
These expenses are considered fixed because they don’t depend on the success of your business. However, while your utility costs may stay the same, you may decide to change the facility you are renting, which will lead to increasing fixed costs.
There are ways to reduce your fixed overhead, as many companies want to help emerging firms and create long-term partners. One such factor is affordable hosting for your online business. Good server infrastructure can make the difference between a successful and a failed startup.
Knowing the variable manufacturing costs will help you understand your end price. Both fixed and variable costs need to be taken into account, but remember that payments that stay the same, like rent, have less of an effect than payments that change.
You need to be able to accurately calculate variable costs and make decisions that won't hurt your profit margins for the production process to work. Maybe some products or services you’re offering are less profitable than others, so it pays off more to remove them from your offer and allocate resources to more profitable ones.
Alternatively, you can examine what variables prevent the product from being more profitable. Maybe you can source the materials from a different company for a lower price or make a one-time investment in better equipment to make the manufacturing process more efficient.
Whatever the case, knowing how to find the variable cost per unit can help you plan your production and grow your small business while successfully scaling it to meet demand.
The market’s prices constantly change. Therefore, adjusting your budget will help you improve your bottom line and help your business stay afloat.
Variable costs depend on multiple factors, such as the price of materials, the labor required to meet stock demands, the equipment that needs to scale with the production requirements, fees incurred by payment processors, packaging, and shipping.
The total sum of these expenses plus any additional factors that your specific product requires in order to be shipped to the end user is the variable cost.
If you don’t have a variable cost for your company’s products, you can calculate the value based on the total expenses incurred during a given period. Just take the total sum of expenses and subtract the fixed costs we discuss in this guide. This result will represent total variable costs.
Divide it by the number of units produced in that period, and you will get the average variable cost.
Fixed costs are monthly bills your business needs to pay to stay operational. These do not directly impact your production, and increased demand won’t change what you need to pay. Fixed costs are, therefore, just a sum of bills, services, and employee wages.
To figure out the variable cost, you need to take into account the cost of raw materials, transaction fees, the number of hours it takes to make the product, and the cost of delivering and packing it.
Learning how to find a variable cost for a specific product is best done through an example. Let’s say that your business manufactures paints. You need to account for the materials required to produce these paints. Raw materials in this example are pigments, mediums, and paint bottles with company branding.
Labor would account for workers who mix the ingredients and operate the machinery that produces the finished product. Make sure the product is safely packaged and shipped so that it doesn’t get damaged before it gets to the end user.
Other variable costs would be transaction fees, marketing costs, and other costs that depended directly on how much paint the business made.
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