A Small Business Guide to Variable Costs

A Small Business Guide to Variable Costs

Variable costs are those that fluctuate with production levels. These are contrasted with fixed costs, which do not vary with the production level. Knowing how to manage your variable costs goes a long way in helping you achieve profitability and success as an entrepreneur.

The variable costs are raw materials, power (electricity), and fuel. These costs are closely related to production output, as long as production levels remain within accepted safe limits. For example, if you own a factory that makes wood furniture and wants to see how much it will cost to make one table, you would add the cost of your materials and then divide it by the number of tables made.

All batch costs will be variable if an item is produced in batches, as with cookies or crayons. The same holds for custom products that are built on order. The custom order cost and the one-time delivery cost would also be variable. Fixed and variable expenses make up 50 percent of a typical small business budget.

You can monitor your variable expenses by looking at what you spend on raw materials, power, and fuel. You can also look at the total variable costs for a year to see how much you have spent and what you have been able to sell for.

Variables in the context of business:

The main variables in a business are costs that are influenced by input levels, such as materials and labor. The amount of labor required to produce an item is called direct labor, while the actual work done by labor is called overhead (opposed to natural).

How to control variable costs:

To manage variable costs, you will have to monitor your process. For example, if you are making repair parts for a machine that cuts long metal parts into short lengths, you will have to watch the type of metal used and the amount of time required for each cut. If you can see any slowing down in your process and your materials or labor costs are rising too high, change production methods or buy more fabric or labor.

Two ways to reduce fixed costs are by using more efficient processes and equipment and purchasing cheaper but possibly lower-quality materials. The second way saves on overhead while still producing a high-quality product.

Fixed costs in the context of business:

Most management and marketing classes look at fixed costs as the same as overhead, but this is not true. Fixed costs are left when the fixed expenses have been subtracted from the gross profit. Fixed payments are those that do not change with production or output levels. Examples of fixed costs are rent, insurance, and other ongoing shop expenses. Fixed costs can be reduced by moving to a more efficient facility, facilitating payroll, or selling off inventory or stock.

You can monitor fixed costs by looking at what you are spending on rent and insurance. You can also look at the total fixed expenses for a year to see how much you have spent and what you have been able to sell for.

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