Variable costs are costs that change as the quantity of the good or service that a business produces changes.Garrison, Noreen, Brewer. Ch 2 - Managerial Accounting and Costs Concepts, pp 48 Variable costs are the sum of

marginal cost In economics, the marginal cost is the change in the total cost that arises when the quantity produced is incremented, the cost of producing additional quantity. In some contexts, it refers to an increment of one unit of output, and in others it ...

s over all units produced. They can also be considered normal costs.

Fixed cost In accounting and economics, 'fixed costs', also known as indirect costs or overhead costs, are business expenses that are not dependent on the level of goods or services produced by the business. They tend to be recurring, such as interest or r ...

s and variable costs make up the two components of total cost. Direct costs are costs that can easily be associated with a particular

cost object A cost object is a term used primarily in cost accounting to describe something to which costs are assigned. Common examples of cost objects are: product lines, geographic territories, customers, departments or anything else for which management ...

.Garrison, Noreen, Brewer. Ch 2 - Managerial Accounting and Costs Concepts, pp 51 However, not all variable costs are direct costs. For example, variable manufacturing overhead costs are variable costs that are

indirect costs Indirect costs are costs that are not directly accountable to a cost object (such as a particular project, facility, function or product). Like direct costs, indirect costs may be either fixed or variable. Indirect costs include administration, p ...

, not direct costs. Variable costs are sometimes called unit-level costs as they vary with the number of units produced. Direct labor and overhead are often called conversion cost,Garrison, Noreen, Brewer. Ch 2 - Managerial Accounting and Costs Concepts, pp 39 while direct material and direct labor are often referred to as prime cost. In

marketing Marketing is the process of exploring, creating, and delivering value to meet the needs of a target market in terms of goods and services; potentially including selection of a target audience; selection of certain attributes or themes to emph ...

, it is necessary to know how costs divide between variable and fixed. This distinction is crucial in forecasting the earnings generated by various changes in unit sales and thus the financial impact of proposed marketing campaigns. In a survey of nearly 200 senior marketing managers, 60 percent responded that they found the "variable and fixed costs" metric very useful.Farris, Paul W.; Neil T. Bendle; Phillip E. Pfeifer; David J. Reibstein (2010). ''Marketing Metrics: The Definitive Guide to Measuring Marketing Performance.'' Upper Saddle River, New Jersey: Pearson Education, Inc. . Content used from this source has been licensed under CC-By-SA and GFDL and may be reproduced verbatim. The

Marketing Accountability Standards Board (MASB) The Marketing Accountability Standards Board (MASB), authorized by the Marketing Accountability Foundation,MASB''Marketing Accountability Foundation (MAF)''. ited 8 December 2010/ref> is an independent, private sector, self-governing group of acad ...

endorses the definitions, purposes, and constructs of classes of measures that appear in ''Marketing Metrics'' as part of its ongoin
Common Language in Marketing Project
The level of variable cost is influenced by many factors, such as

fixed cost In accounting and economics, 'fixed costs', also known as indirect costs or overhead costs, are business expenses that are not dependent on the level of goods or services produced by the business. They tend to be recurring, such as interest or r ...

, duration of project,

uncertainty Uncertainty refers to epistemic situations involving imperfect or unknown information. It applies to predictions of future events, to physical measurements that are already made, or to the unknown. Uncertainty arises in partially observable ...

and discount rate. An analytical formula of variable cost as a function of these factors has been derived. It can be used to assess how different factors impact variable cost and total return in an investment.

Explanation

Example 1

Assume a business produces clothing. A variable cost of this product would be the direct material, i.e., cloth, and the direct labor. If the business uses a room, a sewing machine, and 8 hours of a laborer's time with 6 yards of cloth to make a shirt, then the cost of labor and cloth increases if two shirts are produced, and those are the variable costs. The facility and equipment are fixed costs, incurred regardless of whether even one shirt is made. The amount of materials and labor that goes into each shirt increases with the number of shirts produced. In this sense, the cost "varies" as production varies. In the long run, if the business planned to make 0 shirts, it would choose to have 0 machines and 0 rooms, but in the short run, even if it produces no shirts it has incurred those costs. Similarly, even if the total cost of producing 1 shirt is greater than the revenue from selling the shirt, the business would product the shirt anyway if the revenue were greater than the variable cost. If the revenue that they are receiving is greater than their variable cost but less than their total cost, they will continue to operate will accruing an economic loss. If their total cost is less than their variable cost in the short run, the business should shut down. If revenue is greater than their total cost, this firm will have positive economic profit.

Example 2

Over a one-day horizon, a factory's costs may be almost entirely fixed costs, not variable. The company must pay for the building, the employee benefits, and the machinery regardless of whether anything is produced that day, and for the sake of employee relations it may decide to pay them even if a bomb threat requires them all to be evacuated. The main variable cost will be materials and any energy costs actually used in production. Over a six-month horizon, the factory will be better able to change the amount of labor to fit the desired output, either by using overtime hours, laying off employees, or hiring new employees. Thus, much of their labor becomes a variable cost-- though not the cost of the managers, whose salaries are paid regardless of output. Over a five-year horizon, all costs can become variable costs. The business can decide to shut down and sell off its buildings and equipment if long-run total cost exceeds their long-run total revenue, or to expand and increase the amount of both of them if their long-run total revenue exceeds their long-run total cost, which would include their variable costs. It can change its entire labor force, managerial as well as line workers. Thus, which costs are classified as variable and which as fixed depends on the time horizon, most simply classified into short run and long run, but really with an entire range of time horizons.

Common Examples of Variable Costs

While variable costs are a part of anything business related, some common examples include sales commissions, labor costs, and the costs of raw materials.

Notes

References