What are variable costs?
Variable costs are the costs of production, mainly the raw materials that are needed to manufacture a product. Casual labor is also a variable cost, certain times of the year a business might need an extra hand, but it’s not calculated into the budget for every month of the year. Commissions paid to agents are also an example of variable costs – if there is no sale, there is no payout. Credit card fees on certain accounts, transport and repairs are also variable costs. Generally, variable costs fluctuate in relation to labor and capital.
It is noteworthy that all costs are essentially variable. If a business loses money and decides to hire a smaller property from where to run the business in order to cut losses, these costs become variable – even though rent is traditionally a fixed cost. Along with rent, insurance, advertising, taxes, and insurance need to be paid regardless of whether there is output or not and are also called fixed costs. However, there are also mixed costs, such as utilities – the bills will vary, but they will always be there.
The difference between fixed and variable costs
Variable costs are the sum of marginal costs over production and is referred to as normal costs. Fixed and variable costs are the two elements of the total cost. Anyone who wants to succeed in business should know this, analyzing costs correctly will determine the success of a venture. A quick comparison that illustrates the difference clear is the time.
- Time is fixed, no matter what is done with your time – it’s a steady expense.
- The fruits of time is a variable, be it plentiful or mediocre – the same time is lost – and who hasn’t heard that time is money?
So to ensure that a venture is successful in delivering products or services, one must examine everything. You can’t buy an ice cream van and say that it’s an income for life. You buy the soft-serve mix once, and without a platform, or in this case the van – that will need to be maintained. To determine the probability of making profits by selling ice cream in a van, you need to assess:
- the start-up and running costs – which will be the fixed costs, and
- the ingredients and packaging costs – that will be the variable costs must be calculated to get the total cost.
This is a simple example, but when applied to a multi-billion dollar industry, miscalculating the sprinkles on the ice cream will make investors scream and turn to smoothies.
The impact of variable costs on business
Unlike fixed costs, it’s possible to influence variable costs. Not only are variable costs low when business is slow, the venture can constantly seek to cut down on variable costs. Investors prefer to favor the variable costs in the variable–fixed cost ratio. Finding cheaper suppliers, fluctuating markets, and a spectrum of possibilities can drive variable costs to drop. A hike in demand for a certain product will magnify variable costs, but also profit.