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What Is a Variable Cost? A Simple Definition for Small Businesses

A variable cost is an ongoing cost that changes in value according to factors like sales revenue and output. Variable costs include labor, raw materials and distribution costs. Businesses with high variable costs such as contract consulting work have lower margins than other companies but also lower break even points, according to Business Dictionary.

In this article, we’ll cover:

What Is a Variable Cost?

A variable cost is a recurring cost that changes in value according to the rise and fall of revenue and output level. Variable costs include credit card fees and shipping costs.

Small businesses with higher variable costs are not like those with high fixed costs—costs that don’t change with revenue and output, such as rent and insurance. Companies with high variable costs need to produce less to break even but they also have lower profit margins than companies with high fixed costs, according to Business Dictionary.

  • For example, a company relies on materials and personnel to produce goods. If sales increase, the amount of materials and labor needed also increases. If sales decrease, resources and labor needed decreases as well.

Variable costs change based on how many goods are produced or services provided. The more variable costs, the lower the profit margin.

Industries with high fixed costs, like airlines, are less vulnerable to competition. They require huge amounts of investment in machinery and other physical items to start up.

Industries with high variable costs, like the service industry, that depends heavily on labor, are much more vulnerable to competition because there is less investment required to start up.

Total cost is the sum of total fixed costs and variable costs.

What Is a Variable Cost Example?

Variable costs include:

  • Raw materials
  • Commissions
  • Piece rate labor (workers paid for each unit completed)
  • Production supplies
  • Billable staff labor
  • Shipping costs
  • Credit card fees
  • Gas and mileage
  • Specific project costs

 

Example #1

A business consultant has many variable costs because she does many different types of contracts that incur their own specific expenses. On one project, she has to pay for research. She also has to travel to visit the client and the cab fare is a variable expense. She pays an assistant hourly to help her and this billable labor is also a variable cost.

On another project, she needs to travel out of state and all her travel expenses are variable costs. She rents a temporary office to do her work. She buys new software to suit the particular project and she takes a course online to learn the new software. She has to borrow money to buy the new software and finance the training and the interest on that loan is a variable cost as well.

Example #2

An e-commerce business maintains a small warehouse and has to pay it’s hourly staff. Hours worked vary depending on the volume of orders. Shipping costs are a big variable cost for this business. The business has a salesperson who gets commission and a performance bonus.

Example #3

A pet sitting business has to travel to visit clients and the price of gas for the company vehicle is a variable cost, as is the number of miles traveled. Her business cell phone is pay-as-you-go and so is a variable expense. Her staff is paid based on the number of hours worked for clients and their billable hours is a variable expense as well.

Variable Cost Formula

The formula to calculate total variable cost is:

Total Variable Cost = Total Quantity of Output x Variable Cost Per Unit of Output

For example, a pet products company gets an order for 300 leashes for $300. To find variable cost per unit, we take the cost per unit in materials (25 cents) and direct labor costs (30 cents).

300 x (.25 + .30) = $165

Total variable costs would be $165, meaning gross profit would be $135 ($300 – $165).

People also ask:

Is Salary a Fixed or Variable Cost?

Salary is a fixed cost. Salaries do not vary based on production or revenue. They are a regular recurring expense and the amount paid out is set. That said, there may be variable costs on top of a salary. A commission, such as a percentage paid out for every unit sold on top of a salary, is a variable cost because it depends on output, according to Inc..

Is Labor a Variable Cost?

Salaries are not variable costs. They are fixed because they are paid out regularly and are independent of revenue level or production volume. But, other forms of labor are dependent on these factors, according to Accounting Tools.

Piece rate labor is one of these forms. Workers are paid based on every unit they make. Employees that are paid based on billable hours is another variable cost. This happens when a company bills a client for the hours its employees work—they only get paid based on the hours the company can bill.

Commission is also a variable cost as salespeople only get paid if they sell a product or service.

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