How To Calculate Total Variable Costs: Examples And Formulas

By Chris Kolmar - Jan. 6, 2021

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Cost is one of the most significant factors to determine success when running a business. Cost impacts everything in your business. At the end of the day, you want your business to be profitable. Understanding variable costs is a key component to ensuring that happens.

However, the variable cost can sometimes be too abstract for people to wrap their heads around at first glance, especially if they are new to their business endeavors. However, this concept can be tricky to seasoned business professionals, so don’t get frustrated if it hasn’t clicked yet.

Below, we discuss the importance of variable costs, what it is, and how you can find it.

What Are Variable Costs?

Variable costs are defined as the expenses incurred to create or deliver each unit of output. This means the variable costs change depending on various things, including, but not limited to, goods, services, or other products.

These costs are entirely dependent on the organization’s volume of production and will vary based on the amount a company is able to produce. So, if the company produces more or less, the cost will increase or decrease proportionally. For example, Uber pays its drivers for every single ride they complete. This is a variable cost and the primary expense for the company.

Variable costs are different from fixed costs. Fixed costs stay the same regardless of production, and you can generally count on them staying that way. Understanding the total variable costs and the fixed costs of your business is important for a variety of different reasons. It will heavily impact your decision making in different ways.

The Most Common Variable Costs

You can think about variables this way – if a cost varies depending on the volume of any given activity, it can be considered a variable cost. Here are some of the most common variable costs:

  • Direct materials: If the cost object is a product that must be manufactured, the direct materials are likely used as a variable cost. This means if you are using one pound of material for each unit, the direct cost is variable.

  • Direct labor: The determination of direct labor as a variable cost can depend on the type of industry you work in. If you can’t reduce the number of labor employees or their hours worked, this may be classified as a fixed cost.

    However, if you have a fixed number of employees regardless of the output, the number of labor hours may vary depending on the day and the demand. This is classified as a variable cost.

  • Transaction fees: This is an expense that businesses must pay every single time it processes a payment for a customer transaction. This might vary across service providers and may vary depending on the volume or any given order, making it a variable cost.

  • Commissions: Commissions are payments for someone who does something, whether artwork, service work, or sales numbers. For example, if an organization pays a 5% sales commission on every sale they make, the expense will be a variable cost.

  • Utility costs: Utility costs include any expenses incurred by using utilities like electricity, water, sewage, or heating. Utility costs can vary on usage, making them one of the most common and easily identifiable variable costs out there.

  • Staff wages: The more products you create, the more employees you’ll need to handle the workload. This means that your payroll will increase, making this a variable expense.

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  • Packaging and shipping costs: Packaging and shipping of your products may happen by the unit. This means that depending on the number of sales you receive, your variable cost for this will increase or decrease.

The Formula for Variable Costs

Now that we understand better what a variable cost is, the next step is to figure out how to calculate it. This formula can be used to calculate the total variable cost for any particular period of time:

Total Variable Cost = Total Quantity of Output X Variable Cost Per Unit of Output

Here’s how to use this formula in action when determining your organization’s total variable cost. First, identify all variable costs that may be associated with the specific production of the unit. This can include the cost of labor, materials, and overhead costs. Next, add all of these costs together so that you have one single unit. This will allow you to get to the total variable cost for one unit of production.

Once you have that unit, multiply it by the total number of units produced in the time period you’re working with. Once you’ve done this, you’ll have your total variable cost.

Don’t forget to consider costs for production equipment (including computer software), employee wages, commissions, any packaging or shipment costs, translation fees, in addition to the others listed above. It’s a good idea to make a list of these costs so that you can revisit them later when you run through this exercise at a later date.

Variable vs. Fixed Costs in Decision-Making

As mentioned earlier, business costs consist of both fixed and variable costs depending on your work line, type of business, and industry. Variable expenses do not remain consistent if the output product changes. Fixed costs are different because they remain constant regardless of the output. These costs are fundamental to ensuring you take strategic business decisions based on cost.

Depending on the type of business you run, you may have fixed or variable costs that could impact a monumental decision, such as adding new products or closing the doors to a business.

For example, suppose you were thinking about adding a new product to your product line but needed to make sure it made sense financially. In that case, you need to have a decent idea of not only your fixed cost for the business, but what the variable cost for a new product might look like.

This could include things like research and development, new materials, packaging, shipping costs, as well as a commission for your salespeople, varying labor units, and more. This would heavily impact this business decision, especially if the cost of variable expenses outweighed your return on investment.

It will, of course, depend on your business, financial flexibility, and customer appetite. Regardless, understanding variable and fixed costs for your business is the most important piece of running a successful business.

Example of Variable Costs

For businesses looking to calculate their total production cost, variable costs must be understood and calculated close to the dollar to ensure adequate and intelligent business strategies and decisions. So, how do we do this?

Let’s consider a small business that’s selling t-shirts. This process takes time, labor, materials, and essential production equipment. Let’s assume that it costs $10 in raw materials and $20 in direct labor to create a single t-shirt. Additionally, let’s assume there is a fixed business expense for the equipment used to print the shirt at $200. The table below outlines expenses based on the number of t-shirts made, or the variable in this equation.

T-shirts Raw materials Direct labor Variable costs Fixed costs Total costs
1 $10 $20 $30 $200 $230
5 $50 $100 $150 $200 $350
10 $100 $200 $300 $200 $500
20 $200 $400 $600 $200 $800
50 $500 $1,000 $1,500 $200 $1,700

This table illustrates how the variable cost will always increase the total cost as the production amount increases, irrespective of the fixed cost. This is an important concept to keep in mind for any business. It’s significant to understand how much money will be spent based on demand and production ability. Still, it’s also vital to understand the most important cost so that a business owner can ensure they’re not breaking even on their expenses.

Break-Even Analysis

A break-even analysis is a point in which total cost and total revenue are equal. This point analysis can be used to determine the number of units or dollars of revenue necessary to cover total costs – both fixed and variable. To calculate this number, you need to understand and calculate both your fixed costs and variable cost per unit.

The formula for break-even analysis is as follows:

Break-even quantity = Fixed costs / (Sales price per unit – Variable cost per unit)

This is an important number to have as a business owner so that you can understand the minimum amount of any unit of product to cover the expenses for the month or even the year.

Final Thoughts

For any business, goal setting is an important driving factor, especially early on in the process. You’ll want to track what you’re spending and how many resources it’s taking you to get there to improve efficiency both in production and finances as time goes on. Doing these things is imperative to ensuring you run both a successful and efficient business.

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Chris Kolmar

Author

Chris Kolmar

Chris Kolmar is a co-founder of Zippia and the editor-in-chief of the Zippia career advice blog. He has hired over 50 people in his career, been hired five times, and wants to help you land your next job. His research has been featured on the New York Times, Thrillist, VOX, The Atlantic, and a host of local news. More recently, he's been quoted on USA Today, BusinessInsider, and CNBC.

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