Variable cost definition

Variable costs are expenses of a company that do not have a fixed pattern and thus are liable to change. A company incurs two types of expenses: fixed costs and variable costs.

In this article, we learn what variable cost means. We will also study the difference between variable costs and fixed costs.

What is variable cost?

Variable costs in economics are expenses that increase or decrease, depending on various factors such as production volume, sales volume, raw material costs and shipping expenses, among others.

Other common examples of variable costs include labour fees, commissions, utility costs and transactions fees. Since these expenses vary depending on the volume of activity, these will be considered as variable costs.

How to calculate variable costs?

Variable costs are dependent on the production volume or sale volume, since the total variable cost is the product of the total production volume and the variable cost per unit of output. It can be calculated by using the following variable cost formula:

If the production volume increases, the total variable costs will also increase. Fewer products made will lead to lower variable costs.

Variable costs vs fixed costs

Fixed costs are constant expenses that a company has to pay regardless of the volumes of products produced, or the amount of goods or services sold. 

Some common examples of fixed costs are rent and employee salaries, among others. Large corporations typically pay rent for office space via multi-year leases, so whether a company makes enough revenue to cover the cost of the rent or not, it is still obligated to pay its lessor, as stated in the signed contract.

The same goes with employee salaries, which have to be paid regardless of the company’s financial performance. Therefore, unlike variable costs, fixed costs do not change with production output fluctuations.

There is also a class of expenses known as ‘semi-variable expenses’ or ‘mixed costs’, which are a combination of fixed and variable costs. An example of semi-variable expenses is the costs of electricity. The electricity bill will fluctuate with an increase or decrease in production activity, however the company will still have to pay for electricity every month to keep the lights on even if it halts production.

To conclude, fixed costs are considered long-term expenses that do not change over a short period of time, while variable costs are considered short-term expenses that can be adjusted quickly.

Variable costs examples

Let’s say a car manufacturing company plans to use $10,000 to build a car. It pays $7,000 for required raw materials like steel, aluminium and plastic. The carmaker also outsources parts worth $3,000 for the car.

The total variable cost for manufacturing five cars will be 5 x $10,000 = $50,000. Similarly, the carmaker will spend 10 x $10,000 = $100,000 to produce 10 cars. As the production volume increases, the total variable costs for the company also increase. 

The above example has explained variable cost, but what about the company’s fixed costs? Let’s say the company pays $10,000 per month on rent for its factory and $20,000 per month on employee salaries, both of which are fixed costs. These add up to $30,000 per month.

The total expense for the company will be the sum of the above variable costs plus the fixed costs. The company will have to make more revenue than its total expenses in order to post a profit.