Variable costs are regular expenses of every business. Their total amount is proportional to the production and sales level. If it goes up, variable costs increase, 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 tips to reduce them.
Why are variable costs important?
If your sales increase, you decide to produce more units to skyrocket your revenue. At the same time, you need to buy more raw material, pay more for utilities and spend more budget on wages. As a result, this can lead your business either to an ultimate breakthrough or 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 which you can invest in improving your product or expanding your product range. Everything depends on your strategic goals. Lastly, variable costs are extremely important when pricing your product. The higher your expenses are, the more money you'll have to charge for your goods which may have a bad impact on 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 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 material, 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 with the sales changes. They include the basic costs of every company such as rental lease payments, insurance, property taxes, interest expenses, 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 plus them all to see how much it costs to create one unit of your product.
Let's have an example.
Say, you own a bakery and you want to discover the price of one
strawberry charlotte cake that weighs 500g. So, 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 to produce one cake, your company should pay $28 ($13+$5+$10) for variable costs. High production levels will decrease your total costs but don't forget about fixed costs. So, to cover all expenses, get the money needed for investment, and have net income, you need to know some ways to reduce your variable costs.
5 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 discount your provider can make for you. 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 thing is that you’ll probably need some time to find an experienced specialist.
- Invest in high-performing products. Check out which products bring you the most sales and those that have a low-profit margin. Maybe you need to reduce the production of slowly-moving products or even stop manufacturing them and concentrate on your bestsellers. This way, you’ll stop wasting your budget.
- Invest in technology. Look for the process which you can automate with the help of technology, hence, you won’t need to hire a person. For example, you can save some money on customer support staff by developing chatbots that will 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 basic tips to reduce your variable costs. Don’t forget to monitor all your processes, perhaps some of your staff members are not doing their best, so take recruiting seriously, and regularly calculate these expenses.
Last Updated: 22.06.2021