Variable costs

Variable costs are a type of cost that changes in direct proportion to the volume of production or level of activity in a business. They are also known as direct costs or product costs.

Definition

Variable costs are expenses that increase or decrease as a direct result of increases or decreases in production or output levels. They are directly tied to the level of business activity. Examples of variable costs include raw materials, direct labor costs, and sales commissions.

Characteristics

Variable costs have two main characteristics:

1. They change in total with the level of output. If production increases, the total variable cost will increase, and if production decreases, the total variable cost will decrease.
2. The per unit variable cost remains constant regardless of the level of output. This means that for each additional unit produced, the increase in total cost is the same.

Calculation

The variable cost can be calculated by multiplying the variable cost per unit by the number of units produced. The formula is:

Variable Cost = Total Quantity of Output x Variable Cost Per Unit

Variable Cost and Decision Making

Understanding variable costs is essential for business decision making. It helps in:

1. Cost-volume-profit analysis: This analysis helps in understanding the effect of changes in volume and cost on a company's profit.
2. Pricing decisions: Knowledge of variable costs is essential in setting prices.
3. Budgeting: Variable costs are important in preparing flexible budgets.

See also

• Fixed costs
• Semi-variable costs
• Direct costs
• Indirect costs
• Cost behavior
• Cost-volume-profit analysis