Variable cost definition

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What is Variable Cost?

A variable cost is a cost that varies in relation to either production volume or the amount of services provided. If no production or services are provided, then there should be no variable costs. If production or services are increasing, then variable costs should also increase.

How to Calculate Total Variable Costs

To calculate total variable costs, multiply the total quantity of units produced by the variable cost per unit. The formula is:

Total quantity of units produced x Variable cost per unit = Total variable costs

The sum total of all manufacturing overhead costs and variable costs is the total cost of products manufactured or services provided.

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Types of Variable Costs

The main types of variable costs are as follows:

  • Direct materials. This includes the raw materials or components needed to produce goods or services. Examples are fabric for clothing, wood for furniture, and flour for baking.

  • Direct labor. This includes the wages paid to workers directly involved in production or service delivery. Examples are assembly line workers and chefs in a restaurant.

  • Piece-rate labor. This includes any payments made per unit produced or service delivered. An example is the pay for workers assembling parts on a per-unit basis.

  • Commissions. This includes any payments based on sales performance. Examples are sales commissions and affiliate marketing fees.

  • Royalties. This includes any payments based on sales or usage of intellectual property. Examples are the royalties for copyrighted music, and patented technology.

  • Transaction fees. This includes the costs incurred for each sale or transaction, such as credit card processing fees and online marketplace fees.

  • Freight costs. This includes the costs associated with delivering goods to customers. Examples are courier charges and the fuel for delivery vehicles.

  • Packaging costs. This includes the materials and supplies for packing products. Examples are boxes and wrapping materials.

  • Production supplies. This includes the consumables needed for manufacturing or services that are not part of the finished product. Examples are the lubricants for machines, and the cleaning supplies used in restaurants.

Example of Variable Costs

An example of a variable cost is the resin used to create plastic products; resin is the key component of a plastic product, and so varies in direct proportion to the number of units manufactured. As another example, a business only incurs credit card fees when it sells products to customers that are paid for with a credit card; if there are no sales, then there are no credit card fees.

Advantages of Variable Costs

If a company has a large proportion of variable costs in its cost structure, then most of its expenses will vary in direct proportion to revenues, so it can weather a business downturn better than a company that has a high proportion of fixed costs. This can be a major advantage in industries that periodically suffer from sharp declines in sales.