Understanding Variable Costs

Variable costs are business expenses that directly relate to the volume of production or product acquisition in a company. In contrast, fixed costs are those that remain constant regardless of a company’s output. Manufacturing materials, labor expenses and transaction fees are some of the most common examples of variable costs.

Manufacturing Materials

Direct manufacturing materials may be the purest example of a variable cost in a business. In manufacturing, materials costs include the amount you pay to produce the items you sell. If the wood, metal and parts needed to make a widget cost PKR 10 and you produce 2,000 in a month, the monthly direct materials cost is PKR 20,000. In a resale business, you don’t have direct materials costs. Instead, you have production acquisition costs, commonly referred to as costs of goods sold. This expense equals what you pay for each item that you sell.

Variable Labor

A variety of labor costs often are treated as variable costs as well. Direct labor refers to the amounts you pay employees that coincides with production. If you pay a bonus of PKR 0.10 per unit, and your workers make 1,000 units in a month, you incur a direct labor cost of PKR 100. Direct labor goes above basic wages you pay employees for time worked. Billable wages paid to hourly employees for the time they work also meets the variable cost definition in many cases. Commissions paid to salespeople, which equals a percentage of revenue generated, are variable as well.

Transaction Fees

Some variable costs are incurred when you complete transactions. A common example is the credit card processing fee merchants pay each time they complete a purchase transaction. If you pay PKR 0.30 per transaction in a 1,000 sales transaction month, your total variable costs are PKR 300. If you receive payments through PayPal, the transaction fees deducted from your revenue are also variable costs. Shipping costs you pay on each order fulfillment are variable too.

Other Variable Expenses

In some cases, supplies used in production are variable even when not included in creating goods. For instance, you may need fuel or oil for machinery. These supplies are used up based on the level of production. Assuming the business can calculate the actual cost per unit of production, it can treat such supply usage as variable costs. The cost of product packaging for a manufacturer or reseller is another example. Utilities expenses that are tied to machine or equipment usage are also variable.

Credits: Neil Kokemuller

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