What is a Variable Cost? Examples of variable cost 2021

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Variable Cost Definition

A variable cost is a corporate cost that changes in ratio to manufacturing output. Variable costs increase or decrease based on an organization's production quantity; they increase as productivity gains and drop as production declines. Examples of variable costs include the expenses of raw materials and packaging. A variable cost could be compared with a fixed price.

What is a Variable Cost?

KEY TAKEAWAYS

  • A Variable cost is a corporate cost that changes in ratio with manufacturing output.
  • When manufacturing increases, factor prices grow; when production declines, variable costs fall.
  • A variable cost stands in contrast to fixed costs, which don't change regardless of the shift in production levels.

Variable Prices

Recognizing a Variable Price

The total expenses incurred by any company include fixed costs and variable costs. Variable costs are determined by manufacturing output. The variable cost of manufacturing would be a constant amount each unit created. Since the quantity of output and production rises, variable costs will also rise. Conversely, when fewer goods are generated, the varying costs related to manufacturing will therefore decrease.

Examples of variable costs are earnings commissions, direct labor costs, price of raw materials used in manufacturing, and utility expenses. The total factor cost is just the amount of output multiplied by the variable cost per unit of output. Variable costs are often viewed as short-term prices since they may be corrected quickly.

Variable Expenses vs. Fixed Costs

Fixed costs are costs that stay the exact same no matter manufacturing output. If it's the company makes earnings or not, it has to cover its fixed costs, because these costs are independent of output.

Examples of fixed costs are rent, employee wages, insurance policy, and office supplies. A business should still pay its lease for the area it occupies to conduct its business operations no matter the quantity of merchandise manufactured and marketed. If a company increased production or decreased manufacturing, rent will remain the same. Though fixed prices can vary over a time period, the shift won't be associated with manufacturing, and therefore, fixed prices are seen as long-term expenses.

There's also a group of costs that drops between variable and fixed expenses, called semi-variable prices (also referred to as semi-fixed expenses or combined prices ). All these are prices composed of a mix of both variable and fixed elements. Prices are fixed for a set amount of consumption or production and become changeable following this production amount is surpassed. If no production happens, a predetermined price is often nevertheless incurred.

Instance of Variable Costs

Let us presume that it costs a bakery $15 to make a cake$5 to get raw materials like milk, sugar, and bread, and $10 for the immediate labor involved in creating one cake. The table below shows how the variable costs change as the number of cakes baked differ.

1 cake2 cakes7 cakes10 cakes0 cakes
Price of sugars, flour, butter, and milk$5$10$35$50$0
Direct labor$10$20$70$100$0
Total factor cost$15$30$105$150$0

Since the manufacturing output of cakes rises, the bakery's factor costs also increase. After the bakery doesn't bake any cake, then its factor prices fall to zero.

Fixed costs and variable costs include the entire price. The overall cost is a determinant of an Organization's profits, which can be calculated as:

What is a Variable Cost?

A business may increase its profits by decreasing its overall expenses. Since fixed costs are harder to bring down (by way of instance, decreasing lease may entail the business moving into a less expensive place ), many companies attempt to lower their variable costs. Therefore, decreasing prices generally means decreasing factor costs.

If the bakery sells each cake to get $35, its own gross profit per cake will probably likely be $35 - $15 = $20. To compute the net gain, the fixed prices need to be deducted from your gross profit. Assuming that the bakery incurs monthly fixed costs of $900, that includes utilities, lease, and insurance, its own monthly gain will be:

Number SoldTotal Variable PriceTotal Fixed CostTotal CostRevenueGain
20 Cakes$300$900$1,200$700$(500)
45 Cakes$675$900$1,575$1,575$0
50 Cakes$750$900$1,650$1,750$100
100 Cakes$1,500$900$2,400$3,500$1,100

A company incurs a reduction when fixed costs are greater than gross earnings. From the bakery's instance, it's gross gains of $700 - $300 = $400 as it sells just 20 cakes per month. Because its fixed price of $900 is greater than $400, it could drop $500 in earnings. The break-even point happens when fixed prices equal the gross margin, leading to no gains or loss. In cases like this, once the bakery sells 45 cakes for complete factor costs of $675, it breaks.

A business that attempts to raise its gain by decreasing factor costs might want to cut back on varying prices for raw materials, direct labor, and advertisements. On the other hand, the price cut shouldn't impact service or product quality as this could hurt earnings. By decreasing its variable costs, a company increases its gross profit or contribution margin.

The participation margin enables management to ascertain how much profit and revenue could be earned from every unit of the product offered. The contribution margin is calculated as:

What is a Variable Cost?

The contribution margin for the bakery is ($35 - $15) / $35 = 0.5714, or 57.14%. If the bakery reduces its varying prices to $10, its own participation margin increases to ($35 - $10) / $35 = 71.43%. Profits increase when the participation margin rises. If the bakery reduces its factor cost by $5, then it might earn $0.71 for each 1 dollar in earnings.

Related Terms

How to Calculate and Examine a Organization's Running Prices

Running costs are expenses related to normal company operations on an Everyday Basis.

the way to use the Variable Price Ratio

The factor price ratio is a calculation of the prices of raising production compared to the higher earnings that can result.

what's Incremental Cost

Incremental cost is the entire change that a company experiences within its balance sheet because of an additional unit of generation.

Variable Overhead

Variable overhead is the indirect cost of running a company, which fluctuates with all production activity.

How Operating Leverage Works

Running leverage demonstrates how an organization's costs and gain relate to one another and changes may affect gains without affecting earnings, contribution margin, or advertising cost.

Running Ratio

The working ratio indicates the efficacy of business at keeping prices low while generating earnings.

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