A business needs to sell at least a certain number of units or goods to cover all costs to be profitable. This number of units or goods is called the break-even point or quantity. The number of units sold ensures that enough revenue has been made to cover both the variable and fixed costs. In order to understand how variable costs impact your profit margins, it’s useful to know how fixed costs work. Unlike variable costs, this type of expense stays the same regardless of how much (or how little) you produce or sell of your products.

• Variable costs are expenses that change as production increases or decreases.
• Where Y is the total cost, a is the fixed cost, b is the variable cost per unit, and x is the level of activity.
• However, the larger your company gets, the more products it sells, the more money you’ll have to spend on these costs.
• The concept of relevant range primarily relates to fixed costs, though variable costs may experience a relevant range of their own.
• A variable cost will rise and fall depending on sales and production, while fixed costs remain the same.
• Variable costs earn the name because they can increase and decrease as you make more or less of your product.
• Distinguishing between fixed and variable costs is critical because the total cost is the sum of all fixed costs (the total fixed costs) and all variable costs (the total variable costs).

By contrast, the variable cost is the commission paid to the salesperson based on the number of sales they make. So when the salesperson makes 2 sales, they get paid for those, whilst if they make 10 sales, they earn even more. So the cost to the business increases alongside the number of sales.

Is Marginal Cost the Same As Variable Cost?

A variable cost is a cost that changes depending on how much a business produces. In other words, the more goods a business produces, the higher the variable cost. When creating the scatter graph, each point will represent a pair of activity and cost values. Maintenance costs are plotted on the vertical axis (Y), while flight hours are plotted on the horizontal axis (X).

For example, a sales rep might be compensated with a fixed salary along with a commission that fluctuates with sales performance. In this scenario, the commission would https://www.bookstime.com/articles/variable-cost fall into a variable cost category, whereas the salary is fixed. These changing costs are known as variable costs, and they’re an important part of running a business.

Sales Commissions

For instance, one point will represent 21,000 hours and $84,000 in costs. The next point on the graph will represent 23,000 hours and $90,000 in costs, and so forth, until all of the pairs of data have been plotted. Finally, a trend line is added to the chart in order to assist managers in seeing if there is a positive, negative, or zero relationship between the activity level and cost.

• No matter what you plan to do, you should have a plan in place to increase sales and grow your business with time.
• Those costs which are directly related to production will increase the more you produce, while others will remain fixed regardless of production.
• For this example, Company X will base their calculations on a week’s production.
• Cost equations can use past data to determine patterns of past costs that can then project future costs, or they can use estimated or expected future data to estimate future costs.
• You also know how to use the formulas to calculate your variable costs in Google Sheets.
• This could include things like research and development, new materials, packaging, shipping costs, as well as a commission for your salespeople, varying labor units, and more.

As a consultant, you’ll be spending most of your time dealing with a company’s P&L (or the income statement). Because your job is to identify revenue or savings that will drop to the bottom line. And as we’ve already established, cutting variable costs (i.e. outsourcing, replacing parts, optimizing processes) is much easier than cutting fixed costs. You’ll be dealing a lot with these costs throughout your time as a consultant. So get familiar now with how these costs impact a business, and how a variable-cost-based business model differs from a fixed-cost-based business model. Variable cost examples include direct labor, energy and raw materials costs.

Variable Cost Definition

They know what their costs were for June, but now they want to predict their costs for July. If your company makes multiple products, you can get an overall average by summing the average variable cost for each product and dividing it by the total number of products. The more detailed and accurate your expense records, the better you’ll be able to split your costs into the fixed components and the variable ones. In the next section, you will learn the formulas for calculating variable costs.

To learn more about fixed costs and how to calculate them, check out our related article on How To Find Fixed Cost. Fixed costs will stay relatively the same, whether your company is doing extremely well or enduring hard times. Think of them as what you’re required to pay, even if you sell zero products or services. Fixed costs are those that can’t be changed regardless of your business’s performance. Your company’s total fixed costs will be independent of your production level or sales volume. In this guide, we’ll talk about fixed costs and how you can calculate them.

Your salary will be classified as a fixed cost if you are an employee and you have an employment contract, which specifies a set wage per year. The total variable cost will be the number of products in the order, in this case, 200, multiplied by the variable cost of each unit. This means that the calculation for the pet company is 200 x 10 to produce a total variable cost of $2,000. The term “total variable cost” refers to that portion of the overall expense, related to the production of goods or services, that can change in direct proportion to the quantity of production. In scatter graphs, cost is considered the dependent variable because cost depends upon the level of activity.

• In contrast, costs of variable nature are generally more difficult to predict, and there is usually more variance between the forecast and actual results.
• The average total cost definition is the total cost per unit produced in a given time period.
• Therefore, Amy would actually lose more money ($1,700 per month) if she were to discontinue the business altogether.
• Even in the top business schools we teach at, there is some confusion over what exactly is defined as a variable cost.
• As a company strives to produce more output, it is likely this additional effort will require additional power or energy, resulting in increased variable utility costs.
• The number of units produced is exactly what you might expect — it’s the total number of items produced by your company.
• A variable cost is a cost that changes depending on how much a business produces.