The costs associated with operating operations can be divided into two categories: variable and fixed. Variable costs are those that fluctuate with the volume of production, while fixed costs remain constant. Learning how to classify costs is the first step towards managing them and improving the efficiency of your business. Learning how to calculate variable costs will help you reduce costs per unit of production, making your business more profitable.
Steps
Method 1 of 1: Calculate Variable Costs
Step 1. Know the difference between fixed and variable costs
Before categorizing costs, you will need to understand their characteristics.
- Fixed costs remain constant even as the production volume changes. Rentals, bills, and administrative costs are examples of fixed costs. Whether you produce 1 unit or 10,000, these costs will remain roughly the same every month.
- Variable costs change with production volume. Raw materials, packaging and shipping costs, and employee compensation are examples of variable costs. The more units you produce, the higher these costs will be.
Step 2. Classify the costs as fixed or variable
When you have learned the differences between these types of costs, rank all the costs of your business. Many of them, like the examples mentioned above, will be easy to classify. Others may be more ambiguous.
Some costs, which do not follow rigidly fixed or variable patterns, are difficult to classify. For example, an employee might receive a fixed salary plus a commission that varies with sales volume. It is best to divide these costs into fixed and variable elements. Only the commission in this case would be considered variable cost
Step 3. Add up all the variable costs of a given period
Consider, for example, a simple manufacturing activity that has only 3 variable costs: raw materials, packaging and shipping, and personnel expenses.
- Let's assume that the costs incurred in the most recent year are as follows: € 35,000 for raw materials, € 20,000 for packaging and shipping and € 100,000 in wages.
- The total variable costs in the year will therefore be (35,000 + 20,000 + 100,000) € 155,000. These costs are directly related to the production volume for that year.
Step 4. Divide the total variable costs by the production volume
With this calculation you will get the unit variable cost. For example, if the previous activity had produced 500,000 units per year, the variable unit cost would have been (155,000 / 500,000) € 0.31.
- The unit variable cost is simply the variable cost of each unit produced. Each extra unit will increase the costs by that value. If, for example, the previous business produced 100 more units, the variable costs would rise by € 31.
- Note that in most cases, increasing production will still make each unit produced more profitable. This is because the fixed costs would be spread over a larger production volume. If, for example, the previous business spent € 50,000 per year on rents, the rental costs would weigh on each unit for € 0.10. If production doubled, the rent would be charged on each unit for € 0.05, allowing more profit to be made with each sale.
Advice
- Costs that do not behave exactly as fixed or variable are, in some cases, considered "semi-fixed" or "semi-variable". There is room for discretion in setting these costs.
- Note that the previous example calculations can be applied to all currencies.
