Financial modelling terms explained

Variable Cost

Variable costs are expenses that change with a change in the output or the number of units produced by a business. The variable costs are not constant, but depend upon the level of output.

What Are Variable Costs?

Variable costs are those costs that vary with the level of output. They can be either fixed or variable, depending on how they change with output. For example, the cost of raw materials may be a fixed cost if the amount of materials purchased stays the same, regardless of how much product is made. However, the cost of labour may be a variable cost if the number of employees working shifts changes with production.

How Do You Calculate Variable Costs?

There are a few ways to calculate variable costs, but the most common is to use the average variable cost formula. The average variable cost formula takes the total variable cost for a given period of time and divides it by the total number of units produced in that same period of time. This will give you the average variable cost per unit.

Why Is It Important to Know Your Variable Costs?

Variable costs are important to know because they can impact your bottom line. If you know what your variable costs are, you can price your products or services accordingly to ensure you are making a profit. Additionally, if you are looking to make changes to your business (e.g. increase production, add a new product, etc.), you need to be aware of how those changes will impact your variable costs and, consequently, your bottom line.

What's the Difference Between a Fixed Cost and a Variable Cost?

Fixed costs are those that remain unchanged in the short-term, regardless of a company's production levels. For example, rent or lease payments for factory space are typically fixed costs. Variable costs, on the other hand, vary with production levels. The most obvious example of a variable cost is the cost of raw materials. As a company produces more units, it will need to purchase more raw materials, and so the cost of raw materials will increase.

What is An Example of a Variable Cost?

Variable costs are costs that change in proportion to the level of business activity. For example, the cost of raw materials that a company buys to make its products is a variable cost. As the company produces more products, it will need to buy more raw materials, and so the cost of raw materials will increase. In contrast, the rent on a company's office space is a fixed cost, because the company will continue to pay the same amount for the space, regardless of how much or how little it produces.

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