Variable Cost: What It Is and How to Calculate It

Costs are fixed for a set level of production or consumption and become variable after this production level is exceeded. Fixed expenses are those that stay the same each month, such as rent and loan payments. If we talk about what are variable expenses, these are the expenses that fluctuate from month to month, such as utilities, fuel, and inventory costs. While employee salaries are a fixed cost for most businesses, there are some situations where they can be considered a variable expense.

  • Fixed expenses are those that stay the same each month, such as rent and loan payments.
  • In general, a company should spend roughly the same amount on raw materials for every unit produced assuming no major differences in manufacturing one unit versus another.
  • Examples of fixed expenses include mortgage payments, car insurance and cell phone bills.
  • In other words, a variable expense increases when an activity increases, and it decreases when the activity decreases.

I learned a lot about finance after working for a digital marketing company specializing in investing and trading stocks, forex, etc. After that, I got exposed to other verticals such as wealth management and personal finance, which further improved my understanding of the financial world. It’s important to track your spending so you know where your money goes and can plan accordingly. For instance, if you analyze your grocery spending and find that you spent $640 in January, $715 in February and $590 in March, you could add these three numbers together and divide by three.

Variable does not necessarily mean discretionary

Therefore, the cost of shipping a finished good varies (i.e. is variable) depending on the quantity of units shipped. The athletic company also won’t incur some types labor if it doesn’t produce more output. Some positions may be salaried; whether output is 100,000 units or 0 units, certain employees will receive the same amount of compensation. For others that are tied to an hourly job, putting in direct labor hours results in a higher paycheck.

Understanding the difference between the role that fixed and variable expenses play in your life can help you create a budget that prevents you from overspending. It can also help you prepare for other monthly expenditures, such as debt repayment or saving for future expenses. A business that has a high proportion of variable expenses can usually generate a profit on a low sales level. The reason is that there are few fixed expenses to be paid for in each month, making it easier to achieve a breakeven sales level. Now you’re covered for the big one-off bills and even the stuff you don’t see coming with your cushion—including variable expenses into your monthly budget creates some built-in breathing room.

When higher costs seem to spring up out of nowhere, you’ll be prepared instead of worrying where you’ll get the money to cover them. Also, a savings account or emergency fund can provide cash you can dip into at times when your variable expenses are higher than expected. The amount you spend each time may vary, but you’re not paying for those expenses monthly. Instead, you may budget for those kinds of variable expenses using sinking funds—money that you set aside for this purpose. It’s important to understand how much of your expenses are fixed and how much are variable so you can budget your money properly.

Set expense limits and find ways to save

Taking advantage of a 0% introductory balance transfer offer, for instance, could help you save money on credit card interest. This assumes, of course, that you’re able to pay the balance off in full before the promotional rate ends. You could also consider refinancing student loans or consolidating debts with a low-interest rate personal loan to save money. For example, saving money on renter’s insurance, homeowner’s insurance or car insurance may be as simple as shopping around for a better deal with a different insurer.

Discretionary Expenses

A variable expense is a bill you regularly pay with a cost that changes with each period. In some cases, the variable cost only shifts by mere pennies each month, making them easier to estimate. However, some can fluctuate dramatically, making it difficult to estimate it in your monthly budget.

In fact, many of your budget items might be variable expenses rather than fixed, which can make budgeting for them a little more complicated. Note that variable expenses are not considered “variable” because they are discretionary or unnecessary, but because they are fluctuating. For example, your grocery bill can differ from month to month, which makes it variable, but it is not discretionary because it’s not an expense you can do without. As your expenses change throughout the year, you may have more or less to dedicate to the variable costs in your budget, but every dollar helps. When you don’t embrace these true expenses, these costs take a bite out of your budget like a 100-pound shark. Suddenly, big bills don’t elicit the same feeling of a bottomless pit in your stomach.

The costs of keeping your home at a comfortable temperature rise as the weather gets more extreme. During mild months, you spend far less money on heating or cooling systems. Periodic expenses are a form of variable expense that are easier to budget for. These are fixed expenses that are consistently the same, but don’t occur every month. When setting prices, one should ensure that at least the variable expenses are included in the price. That way, a business will not lose money when each unit of a product is sold.

Contribution Margin

However, you can’t reduce the rent or insurance costs, as they’re a necessary category of costs to keep your business running. Although you have to pay the interest each month, the amount varies depending on your interest rate, the loan amount, and how payments you have left. If you’re like most business owners, you’re always looking for ways to cut costs and improve your bottom line. One of the best valuation techniques in private equity ways to do this is by understanding your variable and fixed expenses. In this blog post, we’ll explain what are variable expenses, give some examples, and teach you how to find them in your own business. We’ll also discuss the difference between variable and fixed expenses, and the ways to reduce variable expenses so you can make more informed decisions about where to allocate your resources.

While they may not be necessary for basic needs, certain recurring subscriptions could also be included as fixed expenses in your budget. If you pay for a gym membership or streaming services, for example, those costs might stay the same month to month. A fixed expense just means an expense in your budget that you can expect to stay the same, or close to it, over time.

Another example of a variable expense is a retailer’s cost of goods sold. For instance, if a company purchases a product for $30 and is able to sell it for $50, the company’s cost of goods sold will be a constant rate of 60% ($30 / $50). Therefore, when the company has sales of $10,000 the cost of goods will be $6,000. Costs can vary due to price changes — say, if your city’s bus fare increases — or because of how much of something you buy and how often you do so. For example, say your neighborhood bakery is famous for its $1 mini muffins.

What is an example of variable expense?

Meanwhile, fixed costs must still be paid even if production slows down significantly. A company that seeks to increase its profit by decreasing variable costs may need to cut down on fluctuating costs for raw materials, direct labor, and advertising. However, the cost cut should not affect product or service quality as this would have an adverse effect on sales. By reducing its variable costs, a business increases its gross profit margin or contribution margin.

This can paint a picture of where you can find opportunities to reduce your costs. There are plenty of nonessential costs that you can consider cutting altogether. Take a look at your spending summary from last month, and tally up everything you didn’t need. How much would you save if you made coffee at home instead of buying one at the cafe each morning?

Unless you’re moonlighting as the Hulk, you probably chose the 20-pounder and ate your Wheaties for breakfast. Stay with me and we’ll explain why this choice is the secret to mastering your budget. I’ve written for Life + Money by Citi, Bankrate and The Balance, among others. Take your learning and productivity to the next level with our Premium Templates. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more.

Once you’ve established a firm history with this variable expense, you can adjust it to fit what you’re actually paying. Essentially, if a cost varies depending on the volume of activity, it is a variable cost. Variable costs are usually viewed as short-term costs as they can be adjusted quickly. For example, if a company is having cashflow issues, they may immediately decide to alter production to not incur these costs. It’s important to note that some expenses can fall into both categories. For example, groceries are a non-discretionary expense, but the type of food purchased can be a discretionary expense.

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