- Cost Estimation Methods in Accounting
- Relationship Between Fixed & Variable Costs Used in a Flexible Budget
- IRS Guidelines for Household Expenses
- Absorption Costing vs. Activity Based Costing for Decision Making
- An Introduction to Managerial Accounting & Cost Concepts
- How to Calculate the Market Share to Break Even
Variable costs are expenses that vary in direct proportion to output volume; as volume increases, variable costs increase, and the opposite holds true, as well. Accountants can analyze variable costs for products, departments or entire companies to get an idea of how much money they spend per additional unit of output. Analyzing variable costs can reveal optimum output quantities that allow a company to achieve economies of scale. Unlike fixed costs, variable costs rarely remain the same between two periods. Calculating total variable costs for each period can reveal cost trends that allow you to make more informed managerial decisions.
Add up all variable compensation costs, such as wages and sales commissions. Leave full-time salaries out of the variable-cost equation, since salaried employees incur the same labor expense regardless of output volume. More output almost always correlates to an increase in labor-hours and sales growth, linking wages and commissions directly to volume. Consider any piece-work compensation included in your labor expenses a variable cost, as well.
Calculate the cost of direct materials if your business includes a manufacturing component. Include anything that becomes a tangible part of a finished product, including raw materials like steel, wood and plastic or semi-finished components like computer chips and lenses.
Include the cost of inventory purchased for resale if you operate a retail outlet. Take any volume discounts into account when calculating the cost of inventory or direct materials. Retailers' cost of goods sold can vary based on the size of their purchases and the strategic relationships they form with suppliers. If your variable-cost figures turn out higher than you expected, look to your purchasing policies first to find a solution.
Add up the costs of materials that do not end up as a tangible part of the final product. Account for fuel, oil, chemicals or other component parts used up in production processes. Always remember the litmus test of variable costs when deciding which consumables to include in the calculation: if costs rise proportionally with output, they are variable. Fuel reimbursement for executives at an insurance company would not constitute a variable cost, for example, but fuel expenses for a trucking company would make up a significant portion of variable costs.
Calculate the cost of any overhead expenses that change with different production volumes. Apply the same test you used for consumables in this step. Utilities expenses for a service office open twenty-four hours a day would not count as a variable cost, for example, but utilities for a small production facility that shuts down after meeting production orders would qualify.