Variable Costs

Rafat Abushaban

- Finance #  O 5.3K views   اقرأ بالعربية

Summary: The costs associated with producing products and services are considered Variable Costs. Variable costs can change depending on the amount of products/services being produced, and should be covered by the sales of products and services (in addition to fixed costs) for a business to become profitable.

"Variable Costs" term is usually used to include costs directly linked to producing a certain product or service 1.

These costs are called "Variable" to distinguish them from other "Fixed" costs- See what Fixed Costs are here.

fixed vs variable costs

"Variable Costs" term is usually used to include all costs linked to the running business operations, including (but not limited to):

  • Raw Materials. These include the raw materials that are used in the production of goods and products.
  • Production consumables. These can include power or oil needed to operate machinery.
  • Wages based on output. While salaries may lean toward fixed costs, wages are considered variable costs when paying for part-time staffers, or wages based on the output an employee is creating.
  • Freight costs. Includes costs for freight trucks delivering materials and transporting products to market.
  • Commissions for salespeople and sales channels.

The following table shows the main elements when distinguishing between variable and fixed costs.

 Variable costsFixed costs
MeaningCosts associated with producing products and services that change depending on the quantity producedThe essential operating expenses associated with running the business itself that cannot be avoided
When to considerCalculated according to production (increases with increase in production and decreases with production decrease)Always calculated as long as the business exists, regardless of production, profit or loss
ConstraintsOutput quantity is the main determinant of variable costsTime is the main determinant, as fixed costs persist with time regardless of output
ExampleRaw material costs, direct costs of productionSalaries, fixed taxes, depreciation, and rent

Variable Costs Example:


T-tailors is a company that custom-makes clothes. The company has three employees who design, sew, and prepare clothes. Each of the employees is paid $ 1000 a month, in addition to the monthly rental costs of the place estimated at $ 500 and a standard tax of $ 500. The company buys $ 1,000 yarn and raw materials for a given month. The cost of the electricity that powers production equipment this month is $ 500.
Having this scenario, the we can identify the following:

Variable monthly costsFixed monthly costs
Raw materials (Thread, silks, fabrics, needles) $ 1,000Salaries of 3 employees each are $ 1,000
Power consumption is $ 500The rental costs $ 500
-   Standard tax of $ 500
Total
1000+500=
1500$
Total
3000+500+500=
4000$

We note that the variable monthly costs are $ 1,500 while the fixed costs are $ 4,000

“Variable Costs” are essential variables to learn a business’s Balance Sheet, Contribution Margin, and Break-even point.

Costs that vary in classification according to their continuity


Variable costs can shift and become fixed costs if their continuity changes. For example, take advertising costs. We find some companies allocate specific budgets on a monthly or yearly basis for these ads. In this case, this is a fixed advertising cost. On the other hand, we find other companies that do not allocate a fixed amount, but rather conduct advertising campaigns depending on the season or when launching a new product. In such case, advertising becomes a variable cost.

Can a cost be both variable and fixed?


Sometimes, we find some costs that bear characteristics of variable and fixed costs together. Here, these costs can be thought of as both "variable and fixed" or "mixed".

For example, when a worker is paid a monthly salary, it is considered a fixed cost. Other times an employee is paid as a percentage commission for each unit he/she sells, which would be a variable cost 3 . In contrast, when the employee is paid in the form of a monthly salary plus a commission for each unit he/she sells, then we have fixed + variable costs mixed together. Other costs such as workers' wages may sometimes be called "semi-variable costs" because they are associated with both variable and fixed costs.

Variable costs and Balance Sheets


Understanding variable and fixed costs is crucial for anyone who wants to formulate and understand a Balance Sheets and financial statements in general. The balance sheet is based on three main components: assets, liabilities, and equity. Under the liabilities component, we find a number of fixed and variable costs that the project incurs in order to produce products and services.

balance-sheet

Here it is important to differentiate between the different variable costs that are included in the composition of the balance sheet (often under the Current Assets/Liabilities sections, which looks like the following:

Balance Sheet example

Learn more about Fixed Costs and the Balance Sheet for a better financial understanding to help launch your startup.








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