Examples of Variable Costs
With the explanation mentioned above, these can be a few examples of variable cost in an organisation.
Raw material
Direct labour
Packaging
Transportation expenses
Utility costs
Commissions
Billable labour
Transaction fees, etc.
Variable Cost Formula
The formula for the variable cost is simple as one just needs to add the various kinds of variable expenses made in the organisation.
For instance, a cupcake company produces 20 units of a cupcake, which requires raw materials worth Rs.500, direct labour costs Rs.1000, and packaging cost Rs.200. In this case, the variable cost will be calculated as a sum of raw materials, labour costs, and packaging cost, i.e. Rs. 1700. That is the variable cost to produce a single kind of product. Further, if the raw material costs, labour costs, and packaging costs are mentioned for one unit, then the sum should be multiplied against the number of products produced by the company.
Now, this variable cost can be represented into two different ways
Total variable cost
Average variable cost
Total Variable Cost
To calculate the total variable cost, you need to consider all kinds of products developed or manufactured by the company. First, calculate the variable cost of each unit and multiply it with the quantity of units produced. Repeat the same for all kinds of products and then add the individual variable costs calculated.
Total Variable Cost Formula = cost of manufacture * number of units of the product
For example, a company produces different types of scented candles. They have three products with the flavours Jasmine, lavender, and lily. Now, the variable cost per unit for Jasmine is Rs.10. Variable cost per unit for lavender is Rs.20, and variable cost per unit for Jasmine is Rs.5. The company produces 50 units of Jasmine, 30 units of lavender, and 20 units of lily candles.
Then as per TVC formula, it will be = [(10*50) + (20*30) + (5*20)]
Therefore, the total variable cost will be Rs.1200.
Average Variable Cost
The average variable cost is an estimation of how much it takes to produce one unit of products.
Average variable cost = (TVC of 1st product + TVC of 2nd product + … TVC of nth product) / Number of units produced
Break-Even Analysis
Variable costs play a crucial role in break-even analysis that is useful in the determination of the required revenue, which is sufficient to compensate for all incurred costs (especially fixed cost).
Break-even point (in units) = Fixed costs / (Sales price per unit – Variable costs per unit)
Therefore, companies need to reach their break-even point so that they don’t undergo any losses and head towards earning profit. And hence the study of variable and fixed costs is crucial for students. They need to know the formula to find variable cost so that they can determine business conditions better and perform accordingly.
Since you are now familiar with the concept of variable costs incurred in an organisation, it is about time to test your knowledge. Try answering these questions on your own.
Questions to Answer
Consider the Variable Cost Per Unit as Rs.25 and the Proportion of Sold Items is 5,000 units. The Calculated Total Variable Cost Will be Equal to
Rs.1,35,000
Rs.1,55,000
Rs.1,25,000
Rs.1,50,000
Answer: c
2.The Difference Between Fixed Cost and Variable Cost is Known as
Marginal income
Operating income
Unit income
Fixed income
Answer: b
3.Variable Costing Can also be Called as
Direct costing
Marginal costing
Indirect costing
Both ‘a’ and ‘b’
Answer: d
Since such concepts are significant from a business perspective, it becomes necessary for students to get in-depth knowledge about the topic. In addition to this, they can acquire comprehensive study material from Vedantu’s website or one can download the app to access quality study notes anytime and from anywhere.
FAQs on What Is Variable Cost? Explained
1. What is a variable cost in business and economics?
A variable cost is a corporate expense that changes in direct proportion to the volume of goods or services a business produces. In simple terms, if production increases, total variable costs increase, and if production decreases, total variable costs decrease. Unlike fixed costs, these expenses are not incurred if there is no production activity.
2. What are some common examples of variable costs for a manufacturing company?
Common examples of variable costs are directly tied to production output. These include:
- Direct Materials: The raw materials used to create the product (e.g., steel for a car, flour for a bakery).
- Direct Labour: Wages paid to workers for the hours they spend directly producing goods.
- Production Supplies: Items like machine oil or packaging materials that are consumed during production.
- Sales Commissions: Payments to salespeople that are based on the number of units they sell.
- Shipping Costs: Expenses for delivering finished goods to customers, which vary with the quantity shipped.
3. How is the Total Variable Cost (TVC) calculated?
The formula to calculate the Total Variable Cost is straightforward. You multiply the variable cost per unit by the total number of units produced. The formula is:
Total Variable Cost (TVC) = Variable Cost Per Unit × Total Number of Units Produced.
This calculation helps a business understand the total expenses that fluctuate with its production level for a specific period.
4. How do you determine the variable cost per unit?
To find the variable cost per unit, you divide the total variable costs by the total number of units produced over the same period. This figure represents the cost of direct materials, direct labour, and other variable expenses required to produce a single item. It is a critical metric for setting prices and performing break-even analysis.
5. What is the main difference between a variable cost and a fixed cost?
The primary difference lies in their behaviour relative to production volume. A variable cost changes in total as production volume changes (e.g., cost of raw materials). In contrast, a fixed cost remains constant in total, regardless of the level of production output (e.g., monthly rent for the factory). However, on a per-unit basis, variable cost remains constant while fixed cost per unit decreases as production increases.
6. How does the variable cost per unit typically behave as production volume changes?
This is a key concept often misunderstood. While the total variable cost increases with production volume, the variable cost per unit is generally assumed to remain constant over a relevant range of activity. For example, if the wood to make one chair costs ₹500, the cost to make 10 chairs will be ₹5000, but the variable cost per unit remains ₹500. This assumption is crucial for cost-volume-profit (CVP) analysis.
7. Why is understanding variable costs so important for business decisions like pricing?
Understanding variable costs is critical for making informed business decisions. For pricing, it helps determine the absolute minimum price a product can be sold for to cover its production expenses. It is also fundamental to break-even analysis, which calculates the sales volume needed to cover all costs. By knowing their variable costs, businesses can set profitable price points and decide on production levels that maximise profit.
8. How does variable cost relate to the concept of contribution margin in accounting?
Variable cost is a foundational component in calculating the contribution margin. The contribution margin is the revenue left over to cover fixed costs after considering variable costs. It is calculated as:
Contribution Margin = Total Sales Revenue - Total Variable Costs.
A high contribution margin indicates that a company has more money available to cover its fixed costs and generate profit, making it a vital metric for assessing profitability and product performance.
