Variable costs are costs that vary depending on how many goods you’re producing or how many services you’re delivering.
When we talk about the costs associated with production, we often break them down into fixed costs and variable costs.
A fixed cost is a cost that doesn’t vary depending on how many goods and services you sell. Variable costs are costs you have in connection with production and sales, which will increase if sales and production increase.
Examples of fixed and variable
Examples of fixed costs, which don’t fluctuate depending on your sales, are rental costs, labor costs, insurance costs and the interest you pay on loans. Depreciation can also be considered a type of fixed cost.
Variable costs can be the cost of purchasing raw materials, electricity that you need to operate your shop or machinery, packaging and shipping costs, and so on.
Different variable costs
These types of costs can be sorted into three categories:
- Proportional variable costs: These costs increase as the production volume goes up, at a rate that matches the production volume.
- Overproportional variable costs: These costs rise as production increases, but they increase faster than production levels, for example raw materials that you have to buy in bulk. If you need to buy 10 pieces of cloth, but you only need 5 for your increased production, then the cost of the raw material will be overproportional.
- Underproportional variable costs: Variable costs that increase at a lower rate than the production levels. An example is your electricity cost, which might increase slightly as you work longer hours to produce goods, but they won’t rise as fast as your production volume does, in other words, as fast as your earnings from all these sales.
You should make sure that your variable costs don’t exceed your selling price, which is what you charge for your goods and services. If your costs are higher than your earnings, you’re operating at a loss.
This can be ok at the start, when you’re trying to build a brand, market your product, get a good reputation and so on—but it’s not viable in the long term.