What is variable cost in small business?
Quick insights
- Variable costs can change based on how much your business produces or sells.
- Fixed costs generally remain the same regardless of your day-to-day business activity.
- Calculating these expenses may help you price products and manage your cash flow.
Running a small business can involve tracking many different business expenses to keep your doors open. You might consider learning what variable costs are to help you manage your budget and price your products effectively. Here's a closer look at how you can identify and calculate these changing expenses as your sales volume fluctuates.
What is a variable cost?
A variable cost is a business expense that changes in proportion to how much you produce or sell. When your production volume goes up, your variable costs increase. When your production slows down, these costs decrease.
A simple way to define variable costs is to think of them as the direct price of doing business on a day-to-day basis. If you make custom t-shirts, the cost of the blank shirts and the ink are variable costs. If you sell 100 shirts one month and 500 the next, your spending on those materials will rise accordingly.
Variable costs vs. fixed costs
To get a full picture of your finances, it may help to look at both fixed and variable expenses. While variable costs fluctuate with your sales volume, fixed costs remain the same no matter how much you sell.
Fixed costs are often the baseline expenses required to keep your business running. These might include your monthly rent, property taxes and business insurance premiums. Even if you have a slow month with zero sales, you still pay your fixed costs. Variable costs only happen when you're actively producing or selling your goods and services.
Examples of variable costs
Every business is different, but many share similar types of fluctuating expenses. Identifying these can help you better manage your cash flow.
- Raw materials: The supplies needed to create your product generally increase as you make more items.
- Packaging and shipping: The cost of boxes, tape and postage often goes up with every additional order you fulfill.
- Sales commissions: If you pay employees a percentage of each sale, your payroll costs could rise as they sell more.
- Credit card processing fees: The fees you pay to process customer payments may increase as your transaction volume grows.
When paying for these everyday expenses, you might consider using a business credit card to potentially earn rewards on your spending. It can also be useful to consider applying for a business bank account to better separate personal and business expenses.
How to calculate variable costs
Learning to calculate your variable costs can be especially useful when building a budget for small businesses. To find your total variable cost, you multiply the cost to make one unit of your product by the total number of products you created.
The formula looks like this: Total variable cost = Total quantity of output x Variable cost per unit of output.
For example, if it costs you $5 in materials to bake one cake and you bake 200 cakes in a month, your total variable cost for that month is $1,000. Tracking this number over time can help you decide if you need to raise your prices or find cheaper suppliers to maintain your profit margins.
The bottom line
Your business expenses may naturally ebb and flow as your sales volume changes. Tracking your variable costs can be a helpful way to monitor your small business finances. By knowing how these expenses shift, you might get a clearer picture of your profit margins. This could help you make more informed pricing and budgeting decisions as you plan for the future.
