What is a variable cost?

Variable costs are business expenses that fluctuate in response to changes in production output or sales volume.

Simply put, as a company produces more goods or sells more services, its variable costs increase.

The key characteristics of variable costs are:

• Variable costs change directly with production volume or sales
• Variable costs can often be expressed as a cost per unit of output
• Businesses can manage variable costs to some extent by influencing production efficiency or pricing strategies

Some examples of variable costs include:

• Raw materials or components directly used in producing goods (e.g. the cost of flour for a bakery or wood for a furniture maker)
• The wages paid to production workers directly involved in creating the product
• Sales commissions paid to salespeople based on their sales volume
• Wages paid to workers based on the number of units they produce
• The cost of shipping finished products to customers
• Energy costs such as electricity used in production facilities

Frequently asked questions

How can companies manage variable costs?

There are some strategies companies can use to manage variable costs:

• Negotiate better pricing with suppliers for raw materials or other variable costs
• Optimize production processes to minimize waste and reduce the amount of materials or labor needed per unit
• Limit unnecessary overtime to decrease labor costs
• Maintain optimal inventory levels to avoid waste and associated storage costs

How do variable costs differ from fixed costs?

Fixed costs are business expenses that remain relatively constant regardless of production volume or sales level, e.g. rent, salaries of administrative staff, etc.

Unlike variable costs, fixed costs don’t fluctuate directly with activity levels.