What are Variable Costs?
Variable costs are expenditures that increase or decrease with the number of goods or services that a business produces.
Variable costs are also called unit-level costs or short-term costs. They are called short-term costs because unlike fixed costs, they are incurred with every good or service that is produced. If there is no production, the variable cost is zero.
As a business owner it is important to know your variable costs so that you can determine your profitability.
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Variable Costs – Example
For example, let’s say that you own a local printing business, and you have to figure out the total variable costs to produce one advertising flyer.
To print one flyer you know that you need:
- Printing paper = $1.00 per unit
- Electricity = $1.00 per unit
- Labour Wages = $3.00 per unit
So, if you want to figure out the variable costs to produce 25 flyers then you would use this formula.
Total Variable Cost Per Unit = Total Quantity of Output x Variable Cost Per Unit
Here’s how this would apply to our example:
- Printing paper = 25 X $1.00 per unit = $25.00
- Electricity = 25 x $1.00 per unit = $25.00
- Labour Wages = 25 x $3.00 per unit = $75.00
Total Variable Cost Per Unit = $25.00 + $25.00 + $75.00 = $125.00
It’s worth noting that this does not include what you already have to pay for your fixed costs (printing machine, office, furniture, lighting etc.)
So, if you decide to produce 0 flyers, your variable cost is zero.
The more units you produce, the higher the variable costs and vice versa.
If you’d like to go even deeper and answer the question ‘Why Should A Business Owner Understand Their Gross Margin?’ then click on this link.
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