What is Variable Cost?

Variable cost is a financial term that describes the costs associated with a business that rise or fall with changes in activity. Variable costs are expenses that change in direct proportion to changes in the production, operations, or sales of a business. Unlike fixed costs which remain the same no matter how much production or sales occur, variable costs do not remain steady, but instead increase or decrease in step with increases or decreases in activity.

Examples of variable costs include the cost of raw materials, labor (including bonus and commission payments), utilities (including those associated with production and sales processes), or distribution costs specific to selling a particular product or service. Variable costs are essential in calculating the contribution margin of a product or service, which measures the economic effect of each unit sold, and is used to calculate the break-even point and the target profit level of a product.

Variable costs should be closely monitored by managers and other business decision makers since fluctuations in the production, operations, and sales of a company can directly affect variable cost figures. Higher variable costs may lead to lower profitability, and careful tracking of variable costs allows management to make required adjustments in resource-allocation decisions. For example, if costs related to variable labor continue to rise, a manager may consider automating tasks to bring variable costs down. Alternatively, if variable costs remain low, a manager may explore opportunities to boost production or other non-cost saving ways to increase profits.

In conclusion, variable costs are an essential factor for any business, as the high- and low-cost of production activities, sales, and production output have a direct effect on the level of profitability. Tracking variable cost figures over time can tell a business owner a lot about the efficiency of their operations, and how much they need to adjust production to reach optimal profitability. By understanding the relationship between variable costs, fixed costs, and contribution margins, business owners can make informed decisions on how best to manage their resources and maximize their profits.