# Variable Cost Definition

Another way of analysing fixed and variable costs is determining the degree of operating leverage. The degree of operating leverage is a way to understand how sensitive Earning Before Interest and Tax is regarding sales. Once you’ve identified your fixed and variable costs and understand how they affect your profitability, you can begin to plan for future growth—and develop contingency plans to handle a rough patch. Running a business involves taking risks, but by understanding your finances, you can set yourself on the path to success. Let’s compare the fixed and variable costs of a few different businesses.

Variable Cost per unit produced or in other words the Average Variable Cost generally remains constant. Variable Cost per unit denotes the per unit cost needed for the labor, raw material, and other resources needed, which fluctuate as the unit produce changes. You’ll need to sell 600 cups of coffee every month if you want your business to be profitable. If you divide that by roughly 30 days in a month, you’ll need to sell 20 cups of coffee per day in order to break-even.

## What is a Variable Cost?

These costs may vary with production, but also are necessary even in the absence of production or sales. The salary is paid even if no What is a Variable Cost Per Unit? sales are made, but commission depends on the sales volume. In this example, the commission is a variable cost and salary is fixed.

There will be some expenses you’ll have more control over, like variable costs. You’ll be able to quickly cut down on these costs to increase profitability. Fixed costs, on the other hand, are more stable, and you often have less control over them.

## Total Variable Cost vs. Average Variable Cost

Variable cost per unit refers to the costs of each unit of goods that a company produces, variable costs change as changes occur in the production level or https://simple-accounting.org/ activity level of the company. Unit Variable Cost is affected by changes in the business, extra cost is incurred when more units of goods are produced.

Some positions may be salaried; whether output is 100,000 units or 0 units, certain employees will receive the same amount of compensation. For others that are tied to an hourly job, putting in direct labor hours results in a higher paycheck. With the calculation of the variable cost per unit, top management gets more defined data, which will help them make decisions that may be required in the future for expanding the business. Packing expenses change with change in the production level and thus will be considered a variable cost. Direct material expenses change with change in the production level and thus will be considered a variable cost. If you’re selling an item for \$200 but it costs \$20 to produce , you divide \$20 by \$200 to get 0.1.

## What Is Variable Cost per Unit?

That’s because the break-even point is lower, due to lower fixed costs, and higher variable costs yields lower profits per unit sold. In addition, a company with higher variable costs can bear economic downturns more easily by reducing production.

Sales on a target profit – The formulas for target profit are different for each business depending on how many products they produce and sell. Calculating target profit is important for a business to determine what they need to price their product at, and how many of each product they need to sell, in order to profit. For example, every car that is produced must have a set of four tires.

## Are Direct Labor & Direct Material Variable Expenses?

The company pays rent in advance for the whole year, so it is a fixed expense and will not be a part of the variable cost. Fixed costs are costs that don’t change in response to the number of products you’re producing. While the cost per unit refers to how much you spend to deliver one unit, the price per unit refers to how much you charge customers for each item sold. Calculating cost per unit is also important, because it gives ecommerce companies an idea of how much they should charge for each of their products to be profitable. A low per-unit cost is an indicator of efficient production and logistics, which ensures profit is being made per sale. Of course, quality plays a role, as higher quality or premium goods typically cost more to produce than less durable or cheaper materials.

• If your variable costs are \$20 on a \$200 item and your fixed costs account for \$100, your total costs now account for 60% of the item’s sale value, leaving you with 40%.
• Potential investors are often very concerned with variable cost per unit when looking at the profit margins of a particular business.
• Let’s assume that it costs a bakery \$15 to make a cake—\$5 for raw materials such as sugar, milk, and flour, and \$10 for the direct labor involved in making one cake.
• For each handbag, wallet, etc. that Coach produces, it incurs a variable cost.
• Additionally, she has experience in the salon, clothing, and retail sectors.
• So in our knife example above,if you’ve made and sold 100 knife sets your total number of units produced is 100, each of which carries a \$200 variable cost and a \$100 potential profit.