How to Calculate Variable Costs

Learn about mixed costs. Sometimes it can’t be easy to categorize certain types of costs as variable or fixed costs. This cost can vary with production, but is also essential even when there is no production or revenue. This cost is called a mixed cost. Mixed costs can still be broken down into fixed and variable components to accurately calculate cost categories.

• An example of a mixed cost is the cost of wages for an employee with salary plus commission. Wages are paid even without sales, but commissions depend on sales volume. In this example, commissions are variable costs and wages are fixed costs. ^[5]
• Mixed costs may also apply to hourly payees if they are guaranteed a fixed number of hours per pay period. Regular hours will be a fixed cost, and any overtime hours will be a variable cost.
• In addition, employee benefit costs can be recognized as mixed costs.
• Another more complex example of mixed costs is utility costs. Whether you produce or not, you still have to pay for electricity, water, and gas. However, electricity, water, and gas usage can increase as production increases. To divide this cost into fixed and variable costs requires a more complex method.

Calculate operations and costs. To divide mixed costs into fixed and variable components, you can use the “maximum-minimum” method. This method starts with the mixed costs from the highest production month and the lowest production month and relies on the difference to calculate the variable cost ratio. First, determine which months have the highest production and which have the lowest. Record the activity in a measurable way (like a timer) and the mixed costs you want to assess for each month. ^[6]

• For example, imagine your company uses a water cutter to cut metal as part of the manufacturing process. Water is required to do this, and water is a variable cost, which increases with the volume of production. However, water costs at your company also arise from operating the production facility (such as for drinking, cleaning, etc.). Thus, the cost of water is a mixed cost.
• Also in this example, the month with the highest water bill is $9,000 with 60,000 man-hours of production. And the month with the lowest water bill is $8,000 and 50,000 man-hours of production.

Calculate the variable cost ratio. Find the difference between both metrics (cost and production) by finding the variable cost level. The variable cost ratio can be calculated using the formula DRAWOLDCHEAP=OLD−cP−p{displaystyle VCR={frac {Cc}{Pp}}} , where C and c are the costs of the highest and lowest months, respectively, and P and p indicate the level of production for those months.

• According to the example above, DRAWOLDCHEAP=$9,000 won−$8,000 won60,000 won−50,000 won{displaystyle VCR={frac {$9,000-$8,000}{60,000-50,000}}} . i.e DRAWOLDCHEAP=$1,000 yen10,000 won{displaystyle VCR={frac {$1,000}{10,000}}} , get 0.10 USD. This means the production cost of each overtime hour is $0.10. ^[7]

Determine variable costs. You can now use the variable cost ratio to determine which of the mixed costs is a variable cost. Multiply the variable cost ratio by the quantity produced to get the variable cost. According to the above example, we take $0,ten×50,000 won{displaystyle $0.10times 50,000} , ie $5,000 won{displaystyle $5,000} , for the lowest month and $0,ten×60,000 won{displaystyle $0.10times 60,000} , ie $6,000 won{displaystyle $6,000} , for the highest month. These are variable costs for each month. You can subtract this from your total monthly expenses to calculate your fixed costs, which comes to $3,000 in both cases. ^[8]

Calculate the moving trend of variable costs. In most cases, an increase in production leads to a higher profit per unit, since fixed costs are divided equally among each unit of production. For example, if a business produces 500,000 units per year and costs $50,000 to rent, then the rental cost is equally divided among each unit at $0.10. If production doubles, the rent per unit is $0.05, as fixed costs per unit go down, so the profit per unit goes up. So as sales increase, cost of goods sold will also increase, but at a slower rate (since the ideal variable cost per unit is constant and the fixed cost per unit decreases). down).

• To determine if variable costs are stable, divide total variable costs by revenue. Through this result you can see how much variable costs account for how much. You can then compare this number with previous variable cost data to see if your variable costs per unit increase or decrease. ^[9]
• For example, if total variable costs are $70,000/year and $80,000 in the following year while revenue is $1,000,000 and $1,150,000 respectively, you can see from the above figure that variable costs change remained fairly stable during those two years at $70,000 won÷$1,000 yen,000{displaystyle $70,000div $1,000,000} , ie 7{displaystyle 7} % of sales in the previous year, and $80,000 won÷$1,150,000 won{displaystyle $80,000div $1,150,000} , or 6,96{displaystyle 6.96} % of sales in the following year).

Use variable cost ratios to assess risk. By comparing the percentage of variable costs with the fixed costs for a unit, you can determine the ratio of each type of cost. You divide the variable cost of a unit by the total cost per unit, using the formula vv+f{displaystyle {frac {v}{v+f}}} where v and f are the variable and fixed costs per unit, respectively. For example, if the fixed cost per unit is $0.10 and the variable cost per unit is $0.40 (total cost per unit is $0.50), then variable costs account for 80% of the cost per unit ( $0,40/$0,50=0,8{displaystyle $0.40/$0.50=0.8} ). As an outside investor, you can use this information to predict potential profit risk.

• If a company has mainly variable costs in production, it may have a more stable cost per unit. Since profit flow is also more stable, we are assuming stable sales.
  • This is true of major retailers like Walmart and Costco. Their fixed costs are relatively low compared to their variable costs which account for a large proportion of the costs associated with per-unit sales. ^[10]
• However, a company with a higher fixed cost ratio may be more likely to take advantage of economies of scale (larger production leads to lower costs per unit) as sales grow faster. much more than the cost.
  • For example, a computer software company has fixed costs associated with product development and support staff, but it can expand its software sales without incurring significant variable costs.
• As revenue declines, a company that relies heavily on variable costs can easily scale back production and still be profitable, while a company that relies heavily on fixed costs will have to find ways to deal with much higher fixed costs per unit. ^[11]
• A company with high fixed costs and low variable costs also has production leverage that increases or decreases profits, depending on sales. Essentially, sales above a certain level are more profitable, while sales below this level are much more costly.
• Ideally, the company should try to balance risk and return by adjusting fixed and variable costs.

Compare with other companies in the same industry. Calculate variable cost per unit and total variable cost for a given company. Then, find the average variable cost data for that company’s industry. This can give you a benchmark against which to judge that company. A higher variable cost per unit may indicate that one company is less efficient than another, while a lower variable cost per unit may represent a competitive advantage. ^[12]

• A higher-than-average variable cost per unit indicates that the company is using a larger amount or spending more on resources (labour, materials, utilities) to produce goods than its competitors. their competition. This could be due to low efficiency or high cost resources. And either way, the company is not as profitable as its competitors, unless it can reduce its costs or raise it higher.
• On the other hand, if the company has the ability to produce the same good at a lower cost, it will realize a competitive advantage by being able to reduce the cost in the market.
• This cost advantage can be attributed to cheaper resources, cheaper labor or greater production efficiency.
• For example, a company can buy cotton yarn at a lower price than its competitors, so it can produce shirts at a lower variable cost and, of course, a lower selling price.
• Trading companies usually publish their financial statements on their websites or the Securities and Exchange Commission (SEC). You can find information on variable costs through their income statement.