Definition
 

An expense that directly varies based on sales or production levels is called a variable cost.

Description
 

The variable's significance Cost is determined by how directly it affects a business's profitability and decision-making procedures. Costs that vary depending on manufacturing volume include labour, utilities, and raw materials.
 

Understanding the variable cost formula, which is typically calculated as

Variable Cost Formula = Cost Per Unit x Number of Units Produced

Companies need to ensure the impact of variations in production volume on their overall expenses and earnings.

By examining variable costs, businesses can make well-informed decisions about budgeting, pricing, and production scaling. For example, if a company is aware of its variable expenses, it can adjust product prices to make sure that profit margins are not affected and expenditures are covered properly.

Understanding variable costs gives the finance management team to efficiently plan a tactical edge in projecting costs and modifying production plans to optimise efficiency. In highly competitive businesses, where cost control can be the difference between profit and loss, this expertise is especially important. Businesses might remain competitive and make profitable strategic judgments by comprehending and utilising variable costs.

Importance to know total variable cost

Here's an elaboration on the importance of knowing the total variable cost:

Budgeting:

For enterprises, understanding the overall variable cost is not just helpful, it's empowering. It enables precise forecasting and distribution of the production budget, allowing businesses to plan for potential contingencies and ensure adequate resources at different production levels. This promotes financial stability and instills confidence in decision-making, preventing overspending and promoting a sense of control.

Pricing:

The price of a product is mainly determined by its overall variable cost. Businesses may set prices that cover costs and generate profit by understanding the cost of manufacturing each unit. A requirement to maintain profitability may be shown by changing prices or cutting costs if the variable costs are too high.

Profitability:

The connection between revenue and costs determines profitability. Businesses can assess their break-even point—the point at which revenue equals total costs—and determine how much profit they make at various production levels by understanding the total variable cost. This knowledge is essential for deciding whether to raise or lower output to maximize earnings.

Decision-Making:

Making well-informed decisions is essential to a business's success. By understanding the total variable cost, businesses can make strategic decisions like increasing or decreasing production, introducing new products, or venturing into untapped markets. But it's not just about big decisions. This understanding also makes resource optimization easier, pointing out areas where expenses may be cut without sacrificing quality. This efficiency leads to more effective operations and better financial results, making the audience feel more in control and confident in their decision-making.

How to calculate variable cost?

This is how you calculate variable cost:

Step 1: Identify Variable Costs

List all expenses that change with the production level, such as raw materials, direct labor, and utilities.

Step 2: Determine Cost Per Unit

Calculate the cost associated with producing one unit of the product. This includes a single unit's materials, labor, and other variable expenses.

Step 3: Measure Production Volume

Determine the total number of units produced or expected to be produced during a specific period.

Step 4: Apply the Variable Cost Formula

Use the formula: Variable Cost = Cost Per Unit x Number of Units Produced. Multiply the cost per unit by the total number of units produced to get the total variable cost.

Step 5: Sum All Variable Costs

If there are multiple variable costs (e.g., different types of raw materials or labor categories), calculate each separately and then add them together to get the total variable cost for the entire production.

Trends that can affect total variable cost for a business
 

Here are four trends that can affect the total variable cost of a business:

• Rising Raw Material Prices

Increases in raw materials can significantly raise the total variable cost, as businesses must spend more to produce the same number of units.

• Labour Cost Fluctuations

Changes in wages or labour availability can impact variable costs. For example, a rise in minimum wage or labour shortages may increase the cost of direct labour.

• Technological Advancements

The adoption of new technology can either increase or decrease variable costs. Automation might reduce labour costs, while new production methods could require more expensive materials.

• Supply Chain Disruptions

Issues such as delays, shortages, or increased transportation costs in the supply chain can result in higher variable costs, as businesses are forced to deal with unexpected expenses to maintain production levels.

Example

Let’s take Nike as an authentic brand example to calculate the total variable Cost.

Example:

Imagine Nike is producing a new line of running shoes.

Identify Variable Costs:

• Raw materials (e.g., fabric, rubber, laces)
• Direct labor (e.g., workers assembling the shoes)
• Packaging materials

Determine Cost Per Unit:

Assume the Cost to produce one pair of running shoes is:

• Raw materials: Rs.20
• Labor: Rs.10
• Packaging: Rs.5

Total Cost Per Unit: Rs.35

Measure Production Volume:

• Nike plans to produce 10,000 pairs of these running shoes.

Apply the Variable Cost Formula:

• Variable Cost = Cost Per Unit x Number of Units Produced
• Rs.35 x 10,000 = Rs.350,000

Sum All Variable Costs:

• The total variable Cost for producing 10,000 pairs of running shoes is Rs.350,000.

FAQ
 

What is a semi variable cost?

Semi variable cost is a cost with both fixed and variable components. It partially changes with production level.

How do variable costs affect profitability?

Variable costs directly impact profit margins. As production increases, total variable costs rise, affecting profitability.