Variable costs are costs that are related to the level of activity and which increase or decrease with the corresponding increase or decrease in the level of activity.
For instance, if you need 2 kilograms of wood to make 1 chair, then you’ll need 200 kilograms of wood to make 100 chairs. More material cost will be incurred to make more units. Therefore, material cost is a variable cost.
Examples of variable costs
Here are some examples of variable costs:
- Direct material cost.
- Direct wages or labor cost (However, if employees are paid fixed salaries which are not dependent on the units produced or time worked, such labor cost will be classified as fixed).
- Overheads which vary with the level of activity
In total terms, variable cost rises with the increase in level of activity and vice versa. This is illustrated in the following graph.
Variable cost per unit remains constant and its graph would look like the following image.
Purpose of analysing variable costs
Managers often analyse total costs according to their behavior. Some of the benefits of analysing variable costs are given below.
- The concept of variable costs helps in determining the profit contribution which helps in calculating breakeven point, i.e., sales required to make no profit no loss.
- It helps in making pricing decisions.
- Managers can periodically review the design of products in an effort to reduce the variable costs by introducing a new design.
- Information about variable costs helps the managers in making budgets and forecasts.