What is variable Cost?
Variable costs involve expenditures that fluctuate in direct correlation to the quantity of goods or services generated by a business. Put simply, they represent expenses that are contingent upon the level of activity within the business operations. These costs exhibit an upward trajectory in tandem with heightened activity levels and conversely reduce as activity levels decrease.
Variable Cost Explained
In the context of business expenses, a company's total costs comprise both fixed and variable expenditures. Variable costs are intricately tied to the level of production output or sales activity. The variable cost per unit of production remains constant. As production and output levels increase, variable costs rise in tandem. Conversely, as production scales down, variable production costs decrease.
Examples of variable costs encompass items such as sales commissions, direct labor expenses, the cost of raw materials used in production, and utility bills.
Example of Variable vs. Fixed Costs in Decision-Making
Shubham is running a car wash business and tussling with financial challenges. In March, his business earned ₹ 50,000 but incurred ₹ 60,000 in cost, resulting in a ₹ 10,000 loss.
Shubham’s cost for car wash is:
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March fixed costs:
Rent: ₹20,000
Water: ₹5,000
Equipment depreciation: ₹3,000
Total March fixed costs: ₹28,000
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March variable expenses:
Cost of soap, wax, and towels: ₹20,000
Total cost of labor: ₹10,200
Total March variable costs: ₹30,200
Even if Shubham closed the business, he would still incur ₹28,000 in fixed costs each month. But if he keeps his business open, he would only lose ₹10,000 per month. (₹50,000 revenue - ₹60,000 cost).
Shutting down the business would lead to a bigger monthly loss of ₹28,000, underlining the need to differentiate between fixed and variable costs.
Shubham should focus on strategies to boost revenue or cut variable expenses, like adjusting car wash prices or optimizing soap, wax, and water use. This would offer him a better chance of long-term financial improvement