What is Variable Cost?
Variable costs are expenses that change in relation to the level of activity or production within a business. These costs are typically direct costs that can be easily traced to a specific product or service. Examples of variable costs include direct materials, direct labor, and commissions.
One of the key characteristics of variable costs is that they tend to increase or decrease in a linear fashion as the level of activity changes. For example, if a company produces 100 units of a product, the cost of the direct materials used to produce those units would be a variable cost. If the company then decides to increase production to 200 units, the cost of the direct materials would also increase, but in a linear fashion.
Variable costs are an important consideration for businesses, as they can have a significant impact on profitability. For example, if a company is able to reduce its variable costs, it may be able to increase its profit margins by selling the same product at the same price while incurring lower costs.
How a business can manage variable costs?
There are several ways that businesses can manage variable costs in order to improve profitability. These include:
Negotiating better prices with suppliers: By negotiating lower prices for direct materials, a company can reduce its variable costs and increase its profit margins.
Improving efficiency: By improving the efficiency of the production process, a company can reduce its variable costs by using fewer resources and materials.
Reducing waste: By reducing waste in the production process, a company can reduce the amount of direct materials it uses, resulting in lower variable costs.
Outsourcing: By outsourcing certain production activities to third-party suppliers, a company can reduce its variable costs by taking advantage of lower labor costs or more efficient production processes.
In conclusion, variable costs are an important consideration for businesses, as they can have a significant impact on profitability. By managing and reducing variable costs, businesses can improve their profit margins and make more informed business decisions.