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Overview of Variable Costs
Definition of
Variable Costs
What are Variable Costs? Variable Costs are business expenses that change in total, in direct proportion to changes in the level of activity or volume of production/sales. This means that if production or sales increase, total variable costs will also increase; if production or sales decrease, total variable costs will decrease. However, the variable cost per unit typically remains constant within a relevant range of activity. Common examples include direct materials used in manufacturing, direct labor (if paid per unit or hour of production), sales commissions, and shipping costs per unit sold. They are a key component of cost behavior analysis.
Activities Related to
Variable Costs
Here is a list of Variable Costs related activities:Â Tracking the quantity of direct materials used per unit produced, Calculating direct labor costs based on production volume, Determining sales commissions as a percentage of sales revenue, Monitoring shipping and packaging costs that vary with the number of units sold, Including variable costs in the calculation of Cost of Goods Sold (COGS), Using variable cost data for Cost-Volume-Profit (CVP) analysis and determining the break-even point.
The Importance of
Variable Costs
Understanding Variable Costs is crucial for businesses because these costs directly impact profitability as sales or production volumes change. Unlike fixed costs, which remain constant in total, total variable costs fluctuate with activity. This information is vital for effective budget planning, forecasting, setting pricing strategies, and making decisions about production levels. Analyzing variable costs helps businesses calculate their contribution margin (Sales Revenue - Variable Costs), which indicates how much revenue is available to cover fixed costs and contribute to profit.
Key Aspects of
Variable Costs
Varies with Activity
Total variable costs increase or decrease in direct proportion to changes in production or sales volume.
Constant Per Unit
While the total varies, the variable cost per unit of activity generally remains the same within a relevant range.
Direct Relationship
Often directly associated with the production of goods or the provision of services (e.g., direct materials).
Key for CVP Analysis
Essential for Cost-Volume-Profit (CVP) analysis, including calculating the break-even point and contribution margin.
Concepts Related to
Variable Costs
Variable Costs are a fundamental classification in Cost Accounting and are analyzed as part of Cost Behavior. They are distinct from Fixed Costs (which do not change with activity levels) and Mixed Costs (which have both fixed and variable components). Variable costs are a crucial component of the Cost of Goods Sold (COGS) and for calculating the Contribution Margin.
Variable Costs
in Action:
The Adventures of Coco and Cami
Coco realizes that the more sandwiches she sells, the more bread, meat, and cheese she needs to buy. Cami sees that the more coffees she makes, the more coffee beans and milk she uses.
Professor A explains that these are Variable Costs – expenses that go up when they sell more and go down when they sell less, but the cost for each individual sandwich or coffee stays about the same.