A variable cost is a cost that changes in relation to variations in an activity. In a business, the "activity" is frequently production volume, with sales volume being another likely triggering event. Thus, the materials used as the components in a product are considered variable costs, because they vary directly with the number of units of product produced.
It is extremely useful to understand the proportion of variable costs in a business, since a high proportion means that a business can continue to function at a relatively low revenue level. Conversely, a high proportion of fixed costs requires that a business maintain a high revenue level in order to stay in business.
Here are a number of examples of variable costs, all in a production setting:
- Direct materials. The most purely variable cost of all, these are the raw materials that go into a product.
- Piece rate labor. This is the amount paid to workers for every unit completed (note: direct labor is frequently not a variable cost, since a minimum number of people are needed to staff the production area; this makes it a fixed cost).
- Production supplies. Things like machinery oil are consumed based on the amount of machinery usage, so these costs vary with production volume.
- Billable staff wages. If a company bills out the time of its employees, and those employees are only paid if they work billable hours, then this is a variable cost. However, if they are paid salaries (where they are paid no matter how many hours they work), then this is a fixed cost.
- Commissions. Salespeople are paid a commission only if they sell products or services, so this is clearly a variable cost.
- Credit card fees. Fees are only charged to a business if it accepts credit card purchases from customers. Only the credit card fees that are a percentage of sales (i.e., not the monthly fixed fee) should be considered variable.
- Freight out. A business incurs a shipping cost only when it sells and ships out a product. Thus, freight out can be considered a variable cost.
In most organizations, the bulk of all expenses are fixed costs, and represent the overhead that an organization must incur to operate on a daily basis. There tend to be far fewer variable costs.