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Variable Cost: What It Is and How to Calculate It

Variable expenses are things you have to pay for that may change from month to month. Groceries, eating out, electricity or other usage-based bills, and household items like toiletries and cleaning supplies are some other examples of variable costs in your budget. Variable costs are a direct input in the calculation of contribution margin, the amount of proceeds a company collects after using sale proceeds to cover variable costs.

  • Variable expenses can be intimidating because you don’t know what the bill will be every month.
  • Liliana Hall is an editor for CNET Money covering banking, credit cards and mortgages.
  • The most common examples of fixed costs include lease and rent payments, property tax, certain salaries, insurance, depreciation, and interest payments.
  • And, if you’re wondering what is a variable expense, it’s an expense that may be higher or lower from one month to the next.

Water, gas and electric bills technically fit under the umbrella of basic living expenses. But these costs can fluctuate from month to month, depending on your usage and the rates your provider charges. Knowing how to include both in a budget is important to avoid overspending.

Understanding Variable Costs

Similarly, if the company produces 1,000 units, the cost will rise to $2,000. This analysis helps you make informed decisions to optimize your restaurant’s profitability. The upside of having variable expenses in your budget is that you have more control over them than you do with fixed expenses.

  • Because it is a bill you pay every month and remains roughly the same, a cell phone is a fixed expense.
  • Usually the price of goods stays relatively stable, and one can attempt to control demand somewhat through marketing and advertising.
  • ​Let’s consider a hypothetical example in the restaurant industry to demonstrate how to calculate and analyze the variable expense ratio.

There are a number of ways that a business can reduce its variable costs. For instance, increasing output using the same amount of material can dramatically cut down costs, provided the quality of goods isn’t impacted. Developing a new production process can help cut down on variable costs, which may include adopting new or improved technological processes or machinery. The more fixed costs a company has, the more revenue a company needs to generate to be able to break even, which means it needs to work harder to produce and sell its products. That’s because these costs occur regularly and rarely change over time.

The cost of the babysitter varies based on the number of hours you need and the worker’s hourly rate. Understanding the difference between the role that fixed and variable expenses play in your life can help you create a budget that prevents you from overspending. It can also help you prepare for other monthly expenditures, such as debt repayment or saving for future expenses.

What Is the Formula for Total Variable Cost?

Variable expenses can quickly lead to more debt if you don’t budget for them. A surprise bill or a holiday season that’s more expensive than expected could easily break your budget and cause you to reach for a credit card. You can also look back at your bank or credit card statements and add up everything you’ve spent on that expense category, then calculate the average. If you’re not actively budgeting, you may wish to start tracking your expenses for a few months.

When making a budget, it’s important to know how to separate fixed expenses from variable expenses. Your personal finances are not the only place you may encounter variable expenses. In a small business, a variable cost is an expense that changes according to production or, in some businesses, with changing weather conditions. Trimming variable expenses is more difficult than cutting discretionary spending.

Variable vs Fixed Costs in Decision-Making

If you have plenty of money left, then you can allow for more liberal variable expense spending, and vice versa when fixed expenses take up more of your budget. With proper planning, even very volatile expenses won’t have to derail your business plans. This is where financial software that helps you manage your budget can help you out.

The envelope system is one budgeting method that can help you balance your variable expenses. You start by assigning categories such as entertainment and transportation to individual envelopes. Then, allocate a certain amount of money to each one and spend only what you’ve designated. This way, you’ll know exactly how much cash you have to cover these shifting expenses. As the production output of cakes increases, the bakery’s variable costs also increase.

For instance, if a company purchases a product for $30 and is able to sell it for $50, the company’s cost of goods sold will be a constant rate of 60% ($30 / $50). Therefore, when the company has sales of $10,000 the cost of goods will be $6,000. There are ways to control variable expenses on account of food by making choices that help reduce your food budget. The cost to package or ship a product will only occur if certain activity is performed. Therefore, the cost of shipping a finished good varies (i.e. is variable) depending on the quantity of units shipped. Along the manufacturing process, there are specific items that are usually variable costs.

The Difference Between Your Credit Card Closing Date and Due Date

In some cases, the variable cost only shifts by mere pennies each month, making them easier to estimate. However, some can fluctuate dramatically, making it difficult to estimate it in your monthly budget. When setting up a monthly budget, it’s critical to account for all your expenses, even those that change regularly. These variable expenses can be a stumbling block for some folks when building a budget, but they don’t have to be.

When the bakery does not bake any cake, its variable costs drop to zero. Variable and fixed costs play into the degree of operating leverage a company has. In short, fixed costs are more risky, generate a greater degree of leverage, and leaves the company with greater upside potential. On the other hand, variable 5 tips on how to hire employees with no money costs are safer, generate less leverage, and leave the company with smaller upside potential. In conclusion, variable expenses play a significant role in determining the effectiveness of a budget. Firstly, it allows you to identify areas where you may be overspending and find ways to reduce your expenses.

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That’s because as the number of sales increases, so too does the variable costs it incurs. Budgeting for variable expenses can be more challenging, as you may not be able to pinpoint exactly how much they’ll add up to from one month to another. If you’re not tracking variable expenses regularly, it could be very easy to under- or overestimate how much of your budget you should allocate to them. This is something you can easily do with a budgeting app, however, which can minimize the odds of variable expenses sideswiping your spending plan.

A variable expense can look quite different each month, and right now, as inflation makes everything cost more, your variable expenses might be creating some major headaches. Variable expenses can make budgeting more challenging because you can’t predict an exact figure. For example, while your daycare bill is the same each month, you may also need to hire a babysitter for a few nights.

Therefore, Amy would actually lose more money ($1,700 per month) if she were to discontinue the business altogether. Essentially, these expenses are costs or spending categories that change over time. While you can’t control the changing prices of categories such as gas and groceries, you can take charge of how you manage these costs.

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