What Is Variable Cost? Definition and Guide Backoffice

Obviously, it’s a good thing when business is booming and you have decent cash flow, as more products or services sold means more revenue. You want to develop a deep understanding of your total variable expenses from the start in order to see where you could save money. Shaving the costs that go into each product makes a huge difference in your bottom line. As sales volume and production volume increase, your variable costs increase, too. These costs are also attached to revenue since the more you sell, the more revenue you earn. An example of a semi-variable cost can be the electricity bill for your business.

As a result, a company would need to buy more materials and perhaps hire more workers to make their products. Because of this, variable costs would increase in line with an increase in demand. Since a company’s total costs equals the sum of its variable and fixed costs , the simplest formula for calculating a company’s VCs is as follows. This example illustrates the role that costs play in decision-making. 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.

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You’ll need to pay for the rent of your garage, utility bills to keep the lights on, and employee salaries. The more oil changes you’re able to do, the less your average fixed costs will be. These costs are likely attributed to your food truck monthly payment, auto insurance, legal permits, and vehicle fuel. No matter how many tacos you sell every month, you’ll still be required to pay $1,000.

Here’s a chart explaining how those variable expenses would work. If they use this model to draw up pricing is it important to consider the loss they would incur if they only sold 20 cakes. $30 x 20 cakes equate to $600 but the cost to produce these cakes was $1000. This means that the company will lose $400 if they only sell 20 cakes when they have forecasted 40 cakes to be sold per week. It’s also a good idea to use record-keeping software that helps you track expenses and your income. This will keep you on top of your day-to-day finances and help you get a better idea of your overall financial outlook. Layeris an add-on that equips finance teams with the tools to increase efficiency and data quality in their FP&A processes on top of Google Sheets.

Is Marginal Cost the Same as Variable Cost?

What your company should aim for are low variable costs that enable larger margins so your business can be more profitable. Rents go up, salaries increase, and insurance premiums tend to rise. However, these costs are fixed in the sense that they don’t change based on your production volume. Whether you sold one phone case or 1 million, the total fixed cost is the same.

Whether a firm makes sales or not, it must pay its fixed costs, as these costs are independent of output. With https://www.bookstime.com/s of $16 per t-shirt, you would need to sell 400 shirts per month in order to break even. You either need to price your graphic t-shirts higher, lower your fixed costs, or figure out how to sell a lot more shirts each month without spending more money. You calculate your break-even volume by dividing your fixed costs by your revenue per unit after variable costs. The need for decisions like these is why it pays to keep an eye on your fixed and variable expenses, as it might lead to fruitful negotiations. You should continuously review your balance sheets, income statements and other financial statements to make any necessary adjustments. Understanding how these costs work will help you figure out what’s best for your company at all times.