Reviewed by Aug 27, 2020| Updated on
Variable cost refers to the part of the operating expense that varies with the activity or quantity of production. In general, the variable expense increases or decreases in the same proportion to the quantity of the output. Variable costs stand in contrast to fixed costs which remain unchanged irrespective of the volume of production.
Understanding Variable Cost
- The business expenditure of a company includes variable costs, fixed costs and semi-variable costs. Variable costs are those which have a direct correlation to the business activity. However, fixed costs are unaffected from the volume of business activities or production or distribution. Fixed costs should be paid irrespective of the volume of business operations.
- Variable costs associated with the production of goods or services include cost of raw materials, labour costs, staff welfare costs and other operating office expenses. Fixed costs include rent for the factory or other building in occupation, insurance for machinery or building and security costs.
- Semi-variable costs are partly fixed up to a level of production and then increase with the production volume. They include the cost of electricity fixed up to a certain number of units of consumption. The cost increases with the next set of units consumed and tends to increase after the level fixed.
- Taking an example of a factory manufacturing toys, the cost of the raw materials which is plastic and screws is a variable cost. However, the rent for the factory is fixed per month and is a fixed cost for the company. The electricity costs are semi-variable, which tend to increase after a certain level of production.
Variable costs form part of the total cost of production. The greater the component of variable costs, the easier it is to recover the costs from sales. A company must bear in mind its variable cost while fixing the selling price of its products. Incremental sales help in the recovery of fixed costs and semi-variable costs. The amount that remains after the recovery of the total cost is profit for the company.