Examples of variable costs
/What is a Variable Cost?
A variable cost is a cost that changes in relation to variations in an activity. In a business, the "activity" is frequently production volume, with sales volume being another likely triggering event. Thus, the materials used as the components in a product are considered variable costs, because they vary directly with the number of units of product manufactured.
Why Are Variable Costs Important?
It is useful to understand the proportion of variable costs in a business, since a high proportion means that a business can continue to function at a relatively low sales level. Even at a low sales level, there are few fixed costs to be paid, so the firm can break even or earn a profit. Conversely, a high proportion of fixed costs requires that a business maintain a high sales level in order to stay in business; in this case, it requires many sales to generate a sufficient profit to offset the fixed costs.
A further reason why variable costs are important is that they are a prime determinant in calculating the contribution margin of a product. Contribution margin is calculated as the net sale price of a product, minus all variable costs. Prices must be set so that the contribution margin is greater than zero, or else a business will have no opportunity to generate a profit.
Types of Variable Costs
Here are a number of examples of variable costs, all in a production setting:
Direct Materials
Direct materials are the raw materials that go into a product. Since they are only charged to expense if the product is sold, they are considered the most purely variable cost of all.
Piece Rate Labor
Piece rate labor is the amount paid to workers for every unit completed (note: direct labor is frequently not a variable cost, since a minimum number of people are needed to staff the production area; this makes it a fixed cost).
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Production Supplies
Production supplies, such as machinery oil, are consumed based on the amount of machinery usage; they vary with production volume, and so can be considered variable costs.
Billable Staff Wages
If a company bills out the time of its employees, and those employees are only paid if they work billable hours, then this is a variable cost. However, if they are paid salaries (where they are paid no matter how many hours they work), then this is a fixed cost. Holiday and vacation time would not be classified as a variable cost.
Commissions
Salespeople are paid a commission only if they sell products or services, so this is clearly a variable cost. All types of commissions, including splits and overrides, can be classified as variable costs.
Credit Card Fees
Fees are only charged to a business if it accepts credit card purchases from customers. Only the credit card fees that are a percentage of sales (i.e., not the monthly fixed fee) should be considered variable.
Freight Out
A business incurs a shipping cost only when it sells and ships out a product. Thus, freight out can be considered a variable cost.
Variable Costs vs. Fixed Costs
In most organizations, the bulk of all expenses are fixed costs, and represent the overhead that an organization must incur to operate on a daily basis. Fixed costs must be incurred, no matter what the activity level of the entity may be, while variable costs are only incurred if there is some amount of activity.