What are variable costs? Definition and examples

It is determined by dividing the cost per unit by the number of units. It is an aggregation of various variable expenses incurred by a business. A variable cost is an expense that fluctuates in proportion to a firm’s level of production. If you sell directly, you’ll be incurring the cost of shipping to your customers, while if you’re shipping in bulk to a store or distributor, you’ll be paying freight costs.

• Maintenance costs are a good example; maintenance is essential but can be delayed if there’s a cash crunch.
• If a companyrents a warehouse, it must pay rentfor the warehouse whether it is full of inventory or completely vacant.
• Xero does not provide accounting, tax, business or legal advice.
• Fixed costs include indirect costs and manufacturing overhead costs.
• Because these costs can vary based on production levels, manufacturing supplies are always considered a variable cost.

For example, last month, your variable costs were $3,000 and your revenue was $5,000. First, the company must determine the variable costs per door-handle. These vary based on output and include Variable Costs Definition & Example factors of production such as Raw Materials, Utility Costs, Commission-based pay, Transportation Costs. Industries with high fixed costs, like airlines, are less vulnerable to competition.

Variable cost vs. fixed cost

An example of a fixed cost is rent, which is a contractual amount to be paid on a regular schedule over a defined period of time. Because variable costs are tied to production, they are usually thought of as a constant amount of expense per unit produced. Variable costs can be challenging to manage as they can vary from month to month, increase or decrease quickly, and have a more direct impact on profit than fixed costs. Understanding the classification of your costs is critical to the calculation. Understanding the difference between variable costs and other costs, such as fixed costs, will allow you to better classify costs correctly.

So as McDonald’s makes more Big Macs, it is able to lower its marginal variable costs. Although its total variable costs will increase, the cost to make an additional hamburger decreases.

How to calculate variable cost

Mrs. Wurzel was quite right; they had been supplied, regardless of cost, from Messrs. Rochet and Stole’s well-known establishment. But the F-35 has been plagued with massive delays and cost overruns—mostly due to design defects and software issues. Malaysian-based entrepreneur Tony Fernandes has turned AirAsia into the most successful low cost airline in southeast Asia. “The sensation these objects presented receded as their cost increased,” notes Rabinowitz. The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles.

To do so, you’ll need to add other variable costs not directly related to the production process. Operating leverage measures the degree to which a business can increase operating income by increasing revenue. A business that generates sales with a high gross margin and low variable costs has high operating leverage. With a higher operating leverage, a business can generate more profit. Fixed costs refer to predetermined expenses that will remain the same for a specific period and are not influenced by how the business is performing. Since most businesses will have certain fixed costs regardless of whether there is any business activity, they are easier to budget for as they stay the same throughout the financial year.

Example of a Variable Cost

Therefore, in most straightforward instances, fixed costsare not relevant for productiondecision, and incremental costs, or variable costs, are relevant for these decisions. Other examples of fixed costs include executives’ salaries, interest expenses, depreciation, and insurance expenses. Examples of variable costs include direct labor and direct materials costs. There is a significant difference between fixed costs and variable costs. Variable costs always vary with production levels, while fixed costs remain the same. For example, direct material costs are always a variable cost, because they will increase or decrease in relation to production levels. Fixed costs and variable costs are two main types of costs a business can incur when producing goods and services.

Because variable costs scale alongside, every unit of output will theoretically have the same amount of variable costs. Therefore, total variable costs can be calculated by multiplying the total quantity of output by the unit variable cost.

Break-Even Analysis

Variable costs are expenses that change based on production levels — rising as production levels rise, and falling when production levels drop. From an accounting perspective, https://online-accounting.net/ fixed and variable costs will impact your financial statements. For instance, you can’t calculate cash flow or pretax income without considering these expenses.

Fluctuations in sales and production levels can affect variable costs if factors such as sales commissions are included in per-unit production costs. Meanwhile, fixed costs must still be paid even if production slows down significantly.