Variable costs are regular expenses of every business. Their total amount is proportional to a company’s production and sales level. If it goes up, variable costs increase, and if sales decrease, so do the costs. These expenses include raw materials, commissions, transaction fees, direct labor, utilities, etc.
In this article, we’ll explain why variable costs matter, review the difference between variable and fixed costs, show how to calculate this type of expense, and share some tips to reduce them.
Why are variable costs important?
If your sales increase, you may decide to produce more units to skyrocket your revenue. At the same time, you need to buy more raw materials, pay more for utilities, and spend more budget on wages. As a result, this can lead your business either to the ultimate breakthrough or some tangible losses. This is a reason why you should regularly calculate your variable and fixed costs.
If you manage to get more sales and find ways to reduce variable costs, you’ll save a lot of money that you can invest in improving your product or expanding your product range. Everything depends on your strategic goals. Lastly, variable costs are crucial when pricing your product. The higher your expenses are, the more money you’ll have to charge for your goods, which may negatively impact your position on the market.
Variable costs are not the only expense an entrepreneur has to cover. They go hand in hand with fixed costs, so let’s make the difference between them clear.
Variable costs vs. fixed costs
Variable costs mean expenses that are affected by the changes in production and sales. If a company increases sales, it will increase production to earn more money. Hence, it will have to spend more on wages, utilities, shipping fees, buy more raw materials, pay more for packaging, etc.
Conversely, fixed costs are not affected by the production level. They are set for a specified time period within a contract agreement and don’t change along with sales. They include basic costs of every company, such as rental lease payments, insurance, property taxes, interest expenses, and depreciation.
Now that you know the difference between these two types of costs, let’s find out how to calculate variable costs.
How to calculate variable costs
To find out your variable costs, you need to keep a record of them and add them all to see how much it costs to create one unit of your product.
Let’s see an example.
Say, you own a bakery and want to discover the price of one strawberry charlotte cake that weighs 500g. You should take into account the following expenses:
- direct material costs per unit: $13
- utilities: $5
- the total cost of labor: $10
It means that your company should pay $28 ($13+$5+$10) for variable costs to produce one cake. High production levels will decrease your total costs, but you should not forget about fixed costs. Hence, to cover all your expenses, you should get the money needed for investment, have a net income, and know how to reduce your variable costs.
Five tips to reduce variable costs
In this section, we’ll offer you some tips that will help you decrease your variable costs and invest money in your business development.
- Ask your suppliers for a discount. The larger the volume of raw materials you buy, the bigger your provider’s discount is. Don’t forget that they are as interested in this deal as you are. Negotiate on some mutually beneficial terms and conditions.
- Outsource some labor if possible. If you work with digital products, you should definitely consider this point. Since freelancers work remotely, you can pay them less than your staff members. The only trick here is that you’ll probably need some time to find an experienced specialist.
- Invest in high-performing products. Check which products bring you the most sales and which have a low-profit margin. Maybe you need to reduce the production of slowly-moving products or even stop manufacturing them, concentrating on your bestsellers. This way, you’ll stop wasting your budget.
- Invest in technology. Look for the process you can automate with the help of technology to eliminate the need to hire a person. For example, you can save some money on customer support staff by developing chatbots that automatically answer clients’ frequently asked questions.
- Update your machinery. Look attentively at the tools vital for production. Do you maintain them correctly? Are they enough for your production volume? Are they updated? Why don’t you buy the latest model to speed up production?
These are some essential tips to reduce your variable costs. Don’t forget to monitor all your business processes, check if your staff members are doing their best, take the recruitment process seriously, and regularly calculate these expenses.
Last Updated: 12.01.2022