What are variable costs, their characteristics, and how to calculate them

What are variable costs?

Variable costs are expenditures that fluctuate depending on your company’s production volume or business activities. Also known as non-fixed costs, these expenses increase when production increases and decrease when production decreases.

Variable costs can affect various aspects of your business operations, such as fixed costs, project schedules and pricing strategies. Examples of these costs include raw materials, direct labor costs and utilities—important components that vary with production.

Since variable costs have a direct impact on net profit, they play an important role in financial reports, especially the income statement. Therefore, if you have these costs under control, you can improve your financial management.

Main characteristics of variable costs

Below are some characteristics of variable costs that will help you better understand their impact on your business:

• Proportional to production volume: As production increases, so do variable costs. However, while the total variable cost may increase, the cost per unit usually remains stable.
• Linear with business activities: The relationship between variable costs and production activities is straightforward — more production means higher costs.
• Trackable and adjustable: Variable costs can be monitored and controlled, giving you the flexibility to adjust them to your financial situation.

Differences between fixed and variable costs

When it comes to managing business expenses, it is important to know the difference between fixed costs and variable costs. The way these two types of costs work is very different, and knowing how to manage them can have a significant impact on profitability. 

As the name suggests, fixed costs are stable and must be paid regardless of business activity. Even if the company temporarily ceases operations or production, fixed costs — such as rent and depreciation — must be covered. 

In contrast, variable costs are more dynamic and change directly with production levels. Let’s explore how these two types of expenses differ and what they mean for your business.

1. Relation to production

An important difference lies in how each cost is related to production:

• Fixed costs:

These costs are not directly related to business activities or production and therefore the fixed costs remain the same whether production increases or decreases. For example, your rent payment remains the same whether you produce 100 units or 10,000 units.

• Variable costs:

Variable costs, on the other hand, fluctuate with production levels. If production increases, so do the costs of raw materials and direct labor. If production slows down, these costs also tend to decrease.

2. Timing

The timing of fixed and variable costs also differentiates them from each other:

• Fixed costs:

Fixed costs are usually planned at longer intervals, such as monthly or annually. These costs are predictable and do not occur on a daily or weekly basis.

• Variable costs:

Variable costs have a much shorter cycle. Depending on production schedules, they can be incurred daily or weekly.

This difference in timing also has an impact on financial reporting. Manufacturing companies often produce daily, weekly or monthly variable cost reports to keep track of production-related expenses. In contrast, fixed costs are reported less frequently — usually on a monthly or annual basis— as they occur at longer intervals.

3. Cost amounts

There is also a significant difference in the amount of fixed and variable costs:

• Fixed costs:

Fixed costs are usually larger and non-negotiable. Think of rent payments, salaries or the repayment of loans — these costs remain constant, no matter how high production is.

• Variable costs:

Variable costs are usually smaller but more flexible. As they are based on production activities, businesses have greater control over them. You can adjust them to meet operational needs, ensuring they are in line with the financial health of your business.

Types of variable costs

Variable costs come in different forms, depending on how they are calculated and applied:

• Total variable cost: The total cost of all variable expenses incurred during a given production period.
• Average variable cost: The average cost per unit, calculated by dividing the total variable cost by the number of units produced.
• Planned variable costs: These costs are directly related to production and can be planned based on operational needs, such as the cost of raw materials.
• Discretionary variable costs: These are optional expenses, such as marketing or maintenance costs, that can be adjusted without affecting profitability.

Examples of variable costs

Here are some common examples of variable costs that can occur in businesses:

1. Raw material costs

One of the simplest examples of variable costs is raw material costs, which are the costs a company incurs for the purchase of key materials or components needed for production. The more products the company manufactures, the more raw materials are required. As production increases, so do raw material costs, making them a prime example of variable costs.

2. Production supplies

Next comes the cost of production supplies, which are the costs for consumables used during the production process. 

As these consumables are directly linked to production, their costs fluctuate accordingly. The higher the production volume, the more consumables are needed — and sometimes they need to be replenished.

3. Labor costs

Wages are another important variable cost factor. These are the wages paid to production workers and vary depending on the level of production. If the company ramps up production, it may need to hire more workers or extend the working hours of existing labors, which increases labor costs. Conversely, these costs decrease when production slows down.

4. Sales commissions

Sales commissions are a common variable cost for businesses that rely on sales teams. These commissions are rewards paid to sales staff based on products sold. Since commission expenses are directly related to sales performance, they increase when sales increase and decrease when sales decrease. This makes them a perfect example of variable costs associated with business activities.

5. Product distribution costs

The last example is the cost of product distribution, which includes the cost of transportation, packaging and shipping insurance for the delivery of finished products to customers. The more products sold, the higher the distribution costs to meet customer demand.

How to calculate variable costs

There are two main methods for calculating variable costs. The first approach is to calculate variable costs per unit based on total costs and fixed costs while the second method is to calculate the total variable costs based on the variable costs per unit.

Calculating variable costs per unit based on total and fixed costs

Here is the formula for calculating variable costs based on total costs and fixed costs:

Variable cost per unit = (total cost – fixed cost) / quantity of products

Example:

In August 2024, PT XYZ, a shoe company, incurred total costs of Rp100,000,000 for the production of 5,000 pairs of shoes. The company’s fixed costs amounted to Rp10,000,000 in the same period.

Application of the formula:

Variable costs per unit = (Rp100,000,000 – Rp10,000,000) / 5,000

Variable costs per unit = Rp18,000

Based on this calculation, the variable cost per unit for PT XYZ in August 2024 is Rp18,000. To determine the total variable cost, you can multiply the cost per unit by the number of units produced.

Total variable costs = Rp18,000 × 5,000

Total variable costs = Rp90,000,000

Calculating the total variable costs based on the cost per unit

Another way to calculate the total variable costs is to multiply the variable costs per unit by the total number of units produced.

Formula:

Total variable cost = cost per unit × total number of units produced

Example of the calculation

Following the previous example, PT XYZ produced 5,000 pairs of shoes in August 2024, with a variable cost per unit of Rp18,000.

Application of the formula:

Total variable costs = Rp18,000 × 5,000

Total variable costs = Rp90,000,000

As can be seen from the calculations, both methods lead to the same result: the total variable cost for PT XYZ in August 2024 is Rp90,000,000. Regardless of whether you use the total and fixed costs or the calculation per unit, both approaches provide a clear picture of total variable costs.

Optimize Cost Management with Aspire

Effective management of variable costs can significantly improve profitability. Keeping track of these expenses ensures your business remains agile and financially healthy.

With Aspire’s Expense Management solution, you can manage variable costs more efficiently. Aspire offers real-time expense tracking, neatly categorized for easy management. It streamlines budgeting and payment processes, saving you valuable time.

Beyond tracking expenses, Aspire’s Payment Gateway allows you to receive payments from multiple sources, including bank transfers and QRIS, ensuring smooth cash flow management.

Aspire has many more features to simplify your financial operations. Want to learn more? Contact our team of professionals today!