What Are Variable Costs?

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Variable Costs (wallstreetmojo.com)

Firms rely on variable cost accounting to determine fluctuations and to control cost per unit. For example, when a firm starts a new project, they try to project future expenses. This is known as the average variable expense of the project. In addition, raw materials, production costs, delivery costs, packaging, and labor tariffs are variable expenses.

Key Takeaways

  • Variable costs are expenses that do not remain constant; they vary with time and are directly affected by the production process.A business incurs fixed and variable expenses by continuing day-to-day business operations.Semi-variable expense is the aggregation of expenses incurred by a business, where some components are fixed costs and others are variable costs. Here, costs are fixed to a specific production level. However, manufacturers incur variable expenses if they increase production beyond that level.

Variable Costs In Economics Explained

Variable costs refer to expenses that fluctuate over time. Businesses incur both variable costs and fixed costs. A fixed cost does not change with time. In contrast, variable expenses are not fixed (they vary over time).

Variable expenses are based on business operations —internal factors and external factors. Variable expenses include raw materials, production costs, delivery costs, packaging, and labor tariffs.

A business cannot always predict expenses. Thus, when a firm starts a new project, they try to gauge a ballpark figure of its future expenses. This is known as the average variable expense of the project.

There is a linear relationship between variable expenses and production. Fixed costs are often seen as unavoidable—employee salaries, electricity, rent, and office expenses. Variable expenses, on the other hand, are often seen as discretionary. Maintenance costs are a good example; maintenance is essential but can be delayed if there’s a cash crunch. The same cannot be said of employee wages.

Types of Variable Cost

Variable cost types are as follows:

#1 – Material Costs

Raw materials are an indispensable component of production. Thus, businesses have to order, purchase, and maintain a stock of raw materials. Further, this Inventory is stored in warehouses and factories. Finally, raw materials are used to make finished goods.However, the actual quantity of required raw material varies. If firms lack operating capital, they can survive with less inventory. It also depends on the demand for the product. When demand is high, production runs at total capacity. When demand is low, production is curtailed. Thus, raw material is considered a variable expense.

#2 – Labor and Workforce 

Every production unit employs a workforce; the workers are compensated using varying remuneration structures. Some are hired hourly; others have a fixed salary—paid at the end of the month. Some receive minimum wages others receive substantial amounts.

Sometimes, there is a sudden fall in the availability of labor—production cannot be stopped—wages hike overnight. Employee wages are related to various direct and indirect factors. Thus, it is considered a variable expense for the firm.

#3 – Associated charges, Fees, and Commissions

From manufacturing to selling the product, business operations are divided into multiple stages. Even when a business fails to make a single sale, it still incurs certain liabilities in the form of associated costs, fees, and commissions.

Similarly, a business offers discounts, sales commissions, and hidden fees to agents and distributors. These expenses fluctuate all the time and are hard to predict. Thus, commissions are considered a variable expense.

#4 – Transportation costs

Transportation costs affect all the stages of the supply chain. Transportation costs depend on location, packaging, and logistics. Transportation costs include the cost of freight, carriage, shipping, transit insurance, cost of operating the fleet, etc.

Businesses have very little control over transportation. It depends on the weather, fuel charges, infrastructure, and conditions. Moreover, the particular government is in charge of infrastructure. Thus transportation costs keep varying.

Formula

To calculate, we apply the variable cost formula.

Variable costs = Cost per unit x Total number of units

After calculating variable expenses, it is applied to conduct a break-even analysis of a firm.

Break-even analysis = Fixed costs/Selling price per unit – Variable cost per unit

Example

In the variable expense equation, the variable expense is a dependent variable—internal and external factors are independent variables. Here, internal and external factors refer to components like production scale, workforce, socio-political environment, etc.

Let’s look at a variable cost example to understand the calculation.Let us assume that a company that manufactures 900 linen shirts daily. To achieve this, the company appoints 45 laborers and pays each laborer $18 for a day’s work.

To calculate variable expenses for 30 days, we apply the given values to the formula:

  • Variable Costs = Cost per unit x Total number of units

  • Variable Costs = 45 x 18 x 30 = $24300

After two months, there was a labor crisis in the city; the labor union went on strike against a new policy introduced by the government. As a result, fewer laborers were available—demand for labor rose—labor wages elevated overnight.

To complete production, the manufacturer is forced to pay each worker: $40 for a day’s work. That is twice the standard rates. But first, let us compute the total expense.

  • Variable Expense = 40 x 45 x 30Variable Expense = $54000

The difference between the costs of production between the two months –

  • 54000 – 24300 = $29700

Thus, external factors caused a $29700 change in variable expense for other months (despite outputting the same production levels).

This article has been a guide to what are Variable Costs and its definition. Here, we explain its types, formula, calculation, and example. You can learn more about it from the following articles –

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.

Semi-variable expense is also called mixed cost. It is the aggregation of expenses incurred by a business, where some components are fixed costs and others are variable expenses. Usually, this is witnessed in mass production—costs are fixed to a specific production level. However, manufacturers incur variable expenses if they increase production beyond that level.

Fixed costs include employee salaries, office rent, electricity bills, etc. These expenses are indispensable (irrespective of production levels). Variable expense, on the other hand, depends on production levels. Variable expenses include raw materials, production costs, delivery costs, packaging, and labor tariffs.

  • Variable Cost Per UnitVariable Costing Income StatementAverage Variable Cost