Variable Cost: What It Is and How to Calculate It Leave a comment

Calculate the total variable cost of production for the company based on the given information. Cost is one of the most significant factors to determine success when running a business. If you want your business to be profitable, understanding variable costs is a key component to ensuring that happens. The break-even point refers to the minimum output level in order for a company’s sales to be equal to its total costs.

Essentially, the variable cost of a product is the ratio of sales versus to the amount you have to spend in order to make those sales. You’ll need to pay for the rent of your garage, utility bills to keep the lights on, and employee salaries. The more oil changes you’re able to do, the less your average fixed costs will be. There will be some expenses you’ll have more control over, like variable costs.

Required

Fixed cost does not change with the increase or decrease in the number of goods or services produced. To calculate the total variable costs for a business you have to take into account all the labor and materials needed to produce one unit of a product or service. The total variable cost formula can then be described as the total quantity of output times the variable cost per unit of output. Be careful that you don’t mix up variable cost with variable costing, which is an accounting method used to report variable cost.

This includes additional marketing costs you may incur as a result of increased production. Make sure to be clear about which costs are fixed and which ones are variable. Take your total https://accounting-services.net/real-estate-bookkeeping-virtual-bookkeepers-for/ cost of production and subtract your variable costs multiplied by the number of units you produced. Fixed costs are those that can’t be changed regardless of your business’s performance.

Total Variable Cost

Since a company’s total costs (TC) equals the sum of its variable (VC) and fixed costs (FC), the simplest formula for calculating a company’s VCs is as follows. If your variable costs are $20 on a $200 item and your fixed costs account for $100, your total costs now account for 60% of the item’s sale value, leaving you with 40%. Your average variable cost uses your total variable cost to What is the Retail Accounting Method, Exactly? determine how much, on average, it costs to produce one unit of your product. Any small business owner will have certain fixed costs regardless of whether or not there is any business activity. Since they stay the same throughout the financial year, fixed costs are easier to budget. They are also less controllable than variable costs because they’re not related to operations or volume.

Regardless, understanding variable and fixed costs for your business is the most important piece of running a successful business. High variable cost businesses primarily focus on increasing their pricing power (think Coach). For each handbag, wallet, etc. that Coach produces, it incurs a variable cost. To maximize each unit of production, Coach has branded its products as a luxury item and charges a premium for each unit of production. High prices, versus high volume at a lower price, is how Coach maximizes profitability. The concept of operating leverage is defined as the proportion of a company’s total cost structure comprised of fixed costs.

Detailed Example of a Variable Cost

Whereas total variable cost is the sum of the variable costs of every unit you produce, average variable cost is the actual variable cost per unit. Calculating the average variable cost is important because it allows you to figure out how your total variable costs would change if you were to increase production or sales. To recognize variable costs, it is important to understand how to categorize costs. Variable costs are those which do not remain constant, specifically when production activities fluctuate. Materials, production labor, and sales commission costs will fluctuate with the number of spark plugs produced and sold, so they are variable costs.

• Additionally, she’s already committed to paying for one year of rent, electricity, and employee salaries.
• It might not be fun, but calculating your fixed costs on a regular basis will benefit your business in the long run.
• They may fall up or down, relying on the amount of money that a company spends to produce.
• Understanding how to use the variable cost formula can help you estimate production and marketing costs, that way the growth of your business isn’t a hindrance to its success.
• These costs are also the primary ingredients to various costing methods employed by businesses including job order costing, activity-based costing and process costing.

Suppose that a consulting company charged 1,000 hours of services to its clientele. Apps like PayPal typically charge businesses per transaction so customers can check out purchases through the app. Businesses that receive credit card payments from their customers will incur higher transaction fees as they deliver more services.