Understanding What a Variable Cost Is and Its Importance
Updated: Sep 30, 2021
Even though business is all about selling products and services that can bring cash in, there also has to be money going out. Business expenses have to be exact, paid for and accounted for in order to keep everything running smoothly.
It can be rather difficult to keep tabs on everything, so it’s important to remember them by category. To put your mind at ease, it may be more favourable to hire an accountant who already has prior knowledge and experience dealing with expenses like variable costs, factoring it into different equations to give you insight into your company’s cash flow.
Continue reading to be introduced to what a variable cost is and why it’s important.
Defining a Variable Cost
A variable cost refers to a business expense that’s involved in the production of goods and services that your company carries out. It can either be direct or indirect costs made throughout the process, with the final amount depending on the production output for a period of time.
If your production output for a month is quite high, expect the variable cost to be as high too. However, if there’s a dip in your production output in the following months, the variable costs will likely follow suit to that amount.
Differentiating a Variable Cost
As mentioned above, there are many other categories when it comes to expenses. It’s important to know what makes a variable cost different from them to have a clearer picture of how much your business is spending. Don’t hesitate to consult your accountant to explain further.
Here are several other terms that you may confuse a variable cost for:
Fixed Cost. A fixed cost is another cost that’s involved with the production of goods and services in your company. However, unlike with a variable cost, the fixed costs will change regardless of the output that was made in the period.
Mixed Cost. A mixed cost is considered to be a hybrid of fixed and variable costs. They’re usually considered fixed units that have to be paid, but there would be additional expenses when that threshold has been surpassed.
Marginal Cost. Marginal costs aren’t always present in producing goods and services, representing any additional units made. Its inclusion is usually taken into account when your business is trying to calculate the total production cost.
Direct Costs. A direct cost is defined as the expenses for a certain product, considered as a subcategory of fixed costs. This is different from variable costs, which is more for the units of the product made.
Identifying a Variable Cost
There are all types of variable costs taken into consideration, from the labour paid to your workers on the production line to the raw materials used to create the product you’ll sell. Shipping costs and advertising expenses are also considered as variables too.
Calculating a Variable Cost
Variable costs are factored into all types of formulas, such as the break-even analysis or the contribution margin being made. These are all essential in determining whether your business is doing good money-wise and if changes have to be made in the future.
To sum it up, a variable cost’s amount is dependent on the production output of a business. It’s rather unique from other types of expenses in your business, and fully understanding its difference will lead you to understand what your financial position is.
Looking for an accountant on the Gold Coast to check your variable costs and calculate? New Wave Accounting provides end-to-end accounting and bookkeeping services that greatly scales and grows businesses. Contact us today!