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Business

How to Calculate Variable Cost for Your Business

Written by MasterClass

Last updated: Jul 27, 2020 • 2 min read

If you’re a small business owner, knowing which of your company’s costs are variable helps you make decisions to ensure your business thrives, even when your production and sales levels are in flux.

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What Are Variable Costs in Business?

Variable costs, or variable expenses, are the costs of running a business that change in proportion to variations in sales volume and production volume. Unlike fixed costs, variable costs are directly dependent on business activity. For example, if you own a coffee shop that accepts credit cards, you'll have to pay a percentage of every sale to the credit card company in the form of a transaction fee. If you make 100 sales one month and 1,000 sales the next, you'll be paying more transaction fees the second month and have a much higher variable cost. As the volume of business activity increases or decreases, your variable costs increase and decrease in tandem.

Variable business expenses are more unpredictable in nature than fixed expenses, but they’re easier to adjust when necessary. For instance, if your coffee shop is struggling and you need to increase your profit margin, it's easier to switch to a cheaper brand of coffee cups (a variable cost) than to renegotiate your rent (a fixed cost).

4 Examples of Variable Costs

These common variable cost examples are typical of most businesses.

  1. Credit card fees: When you choose to accept credit cards at your business, you must pay a percentage of every sale to the credit card company in the form of a transaction fee.
  2. Direct materials: Materials costs are the cost of raw materials that go into producing a product. They increase as you produce more of the product and vice versa.
  3. Wages: Worker wages are variable if they are billed by the hour, as the amount of hours worked can fluctuate. On the other hand, salaries that stay the same no matter how many hours an employee works are a fixed cost.
  4. Sales commissions: Commissions are extra wages that employees receive for exceeding a particular sales threshold and are a tool that employers use to incentivize and reward their workers. Commissions are only paid if a certain quantity of sales are met, making them a variable cost.
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How to Calculate Variable Cost for Your Business

Determining your total variable cost is an essential aspect of the cost accounting process for calculating your business's total costs per month.

  1. Find all variable costs in your financial statements. Review your income statements, balance sheets, and bookkeeping records from the past year and identify all your variable costs.
  2. Add up all your variable costs. Add each individual cost together. The sum equals your total variable cost for one year.
  3. Determine your average variable cost per unit of output. Divide your total variable costs by your total output (the number of units you produced within the year). The result will be the average variable cost for a single product.

Variable Costs vs. Fixed Costs: What’s the Difference?

Whereas variable costs fluctuate depending on increases or decreases in production levels, fixed costs stay the same over a set period of time regardless of a business's sales and production volume. Variable costs are related to output and business activity, while fixed costs are related to time. Variable costs are harder to predict and easier to adjust. Fixed costs are easier to predict and harder to adjust.

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