Variable cost ratio definition
/What is the Variable Cost Ratio?
The variable cost ratio shows variable expenses as a percentage of net sales. It measures how much of each sales dollar is consumed by costs that change with sales volume, such as direct materials, direct labor, sales commissions, and shipping costs. For example, if a product sells for $100 and has variable costs of $60, the variable cost ratio is 60%. The remaining 40% is the contribution margin ratio, which is available to cover fixed costs and generate profit. A lower variable cost ratio generally improves profitability.
How to Use the Variable Cost Ratio
The variable cost ratio can be used in several applications, which are as follows:
Product analysis. The ratio is useful at the product level, in order to understand the amount of margin remaining after variable expenses have been deducted from a sale. This is known as the contribution margin, and is calculated as 1 minus the variable cost ratio.
Breakeven analysis. The ratio is useful at the organizational level, to determine the amount of fixed costs that a business incurs. A high variable cost ratio implies that a business can earn a profit at a relatively low sales level, since there are few fixed costs to pay for. A low variable cost ratio implies that the breakeven sales level is high, in order to pay for the large base of fixed costs.
How to Calculate the Variable Cost Ratio
To calculate the variable cost ratio, divide the variable costs incurred by the related net sales. Variable costs are those costs that directly vary with the sales level. Net sales are gross sales minus all sales returns and allowances. The formula is:
Variable costs ÷ Net sales = Variable cost ratio
Variable Cost Ratio FAQs
Does industry type affect the variable cost ratio?
Industry type has a significant impact on the variable cost ratio because cost structures differ across sectors. Labor- and material-intensive industries, such as retail or food services, usually have higher variable cost ratios since expenses rise directly with sales volume. In contrast, capital-intensive industries like utilities or airlines often have lower ratios because they rely more on fixed costs than variable ones.