Variable Cost: What It Is and How to Calculate It

Fixed costs are expenses that a company pays that do not change with production levels. Unlike fixed costs, variable costs (e.g., shipping) change based on the production levels of a company. Since fixed costs are not related to a company’s production of any goods or services, they are generally indirect. These costs are among two different types of business expenses that together result in their total costs.

  • Understanding variable costs and their impact on profitability is critical for aspiring business owners.
  • Whether a firm makes sales or not, it must pay its fixed costs, as these costs are independent of output.
  • Close monitoring of production and demand patterns allows businesses to adjust variable expenses accordingly.
  • The major lesson here is that in spite of their name, “fixed” expenses are not necessarily set in stone.

All costs like repairs and maintenance, indirect labor, etc., are variable overhead costs. Raw materials are the direct goods purchased that are eventually turned into a final product. If the athletic brand doesn’t make the shoes, it won’t incur the cost of leather, synthetic mesh, canvas, business startup costs or other raw materials. 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. Along the manufacturing process, there are specific items that are usually variable costs.

Final Thoughts on Variable Costs

It’s important not only that you have a budget but also that you make an effort to live your budget. This means that you go beyond simply planning out your budget and commit to the spending rules you’ve laid down for yourself. Living your budget may mean rethinking wants versus needs to avoid overspending.

  • Understanding variable costs makes it easier to price your products correctly.
  • Fixed costs are expenses that remain the same regardless of production output.
  • The best-case occurs if the family uses no benefits other than preventive care and therefore has no variable expenses.
  • Purchasing a new piece of machinery incurs a substantial upfront cost, increasing the business’s break-even point.
  • Your health insurance, car insurance, life insurance, and homeowners or renters insurance are also examples of fixed costs.
  • The client is almost guaranteed to save money, and that’s before factoring in the tax savings that comes with depositing money into the Health Savings Account.

However, since variable costs increase proportionally with an increase in production, they can reduce profit margins if a business significantly increases its production. An operation with low variable costs and high fixed costs can achieve large profit margins if its revenue spikes. Unlike fixed costs, variable costs are directly related to the cost of production of goods or services. Variable costs are commonly designated as the cost of goods sold (COGS), whereas fixed costs are not usually included in COGS.

Construction Variable Cost Example

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. But the amount you pay in any given month could be different from previous payments or ones you’ll make in the future. Aside from being roughly the same amount each month, fixed expenses may also be paid on or around the same date each month.

While the cost of goods sold (COGS) is often considered a variable cost, as it increases with an increase in production, there are elements in COGS that are fixed costs. Lastly, variable costs impact future plans for a business and its production. Whether it’s deciding to purchase assets to reduce variable costs or reducing risk by renting machinery instead of buying it, many decisions for the future are made with variable costs in mind. If Amy did not know which costs were variable or fixed, it would be harder to make an appropriate decision. In this case, we can see that total fixed costs are $1,700 and total variable expenses are $2,300. Variable costs are expenses that vary in proportion to the volume of goods or services that a business produces.

Montana average annual cost of car insurance: $2,755 ($262 below national average)

The major lesson here is that in spite of their name, “fixed” expenses are not necessarily set in stone. If you lose your job or aggressively want to start saving, you could devote a few hours to culling your fixed expenses. These bills cannot easily be changed and are usually paid on a regular basis, such as weekly, monthly, quarterly or from year to year.

This can include anything from salary and wages, commissions, pension plan contributions, and benefits. Hiring a freelancer, needing a plumber for broken pipes, or getting a Certified Public Accountant (CPA) to sort out the books are some common examples. Cutting costs by sourcing lower-quality raw materials can reduce variable costs in the short term but might harm the brand’s reputation and customer trust in the long run. These costs have a mix of costs tied to each unit of production and a fixed cost which will be incurred regardless of production volume.

However, it’s important to point out to the client that the monthly premium is $578 lower than the current plan, and that premium savings can be used to pay for a lot of doctor visits and prescriptions. This can even be done on a pre-tax basis if the client sets up a Health Savings Account and deposits at least a portion of the premium savings into the account. All sunk costs are fixed costs in financial accounting, but not all fixed costs are considered to be sunk. The defining characteristic of sunk costs is that they cannot be recovered. That national average annual cost of car insurance in 2023 was $3,017, according to Qualtrics.

Fixed costs stay the same no matter how many sales you make, while your total variable cost increases with sales volume. Understanding variable costs and their impact on profitability is critical for aspiring business owners. As illustrated previously, focusing on variable costs instead of fixed costs results in a lower break-even point. This makes it easier for a business to attain profitability, as it does not need to produce as many goods to meet its sum of fixed and variable costs.

Example 2: Credit Card Processing Fees

Another example of variable costs would be if a business produces hats at $5 each. But if the company does not produce any hats, it will not incur any variable costs for the production of the hats. Similarly, if it produces 1,000 hats, the variable cost would rise to $5,000.

Examples of fixed costs for an event

Yes, it’s possible that the primary doctor does not participate in the HMO network. The family could still go see their favorite doctor and just pay for the visit with their HSA card instead of using their health insurance. While some people don’t like the HMO gatekeeper model, in this case it has to be considered because the premium difference is huge. This HMO HSA plan offers a monthly premium savings of $890 versus the comparable HSA PPO plan and $1,486 versus the current PPO copay plan!

Instead of the exam, the insurance company may ask you to complete a questionnaire about your health. It may also check your medical records (prescription history and doctor’s records, for instance). No-medical-exam life insurance is available both as term life and as whole life policies. Your health and family health history can affect what you pay for life insurance.