Variable Cost: Definition, Formula & Examples

Variable Cost: Definition, Formula & Examples
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  • 0:01 Definition of Variable Cost
  • 0:42 Formula of Variable Cost
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Lesson Transcript
Instructor: James Carnrite

A marketing, communications, and supply chain professional who has a masters degree in IT Mangement. Has been working with young professionals to develop their leadership styles.

In this lesson, we'll be looking at variable costs, which are those costs that change directly with production. After the lesson, you can test your knowledge with a short quiz.

Definition of Variable Cost

Variable costs are expenses that fluctuate proportionally with the quantity of output. Variable costs are directly tied to the activities of producing volume, which rises when these activities increase and falls when activities decrease. This effect can be related to materials, labor, and sales commissions. For example, if you produce spark plugs, the copper used in production is a variable cost. This means if you stop producing spark plugs, you would no longer have the cost of copper. Additionally, regardless of how many spark plugs you produce, the price of copper for one spark plug remains unchanged.

Formula of Variable Cost

The formula to calculate variable cost is:

Total Variable Cost = Total Quantity of Output * Variable Cost Per Unit of Output

To recognize variable costs, it is important to understand how to categorize costs. Variable costs are those which do not remain constant, specifically when production activities fluctuate. For example, items such as rent, utilities, and executive employee salaries are fixed costs because whether you produce one spark plug or 50,000 spark plugs, these costs will remain constant each month. Materials, production labor, and sales commission costs will fluctuate with the number of spark plugs produced and sold, so they are variable costs.

Understanding the classification of your costs is critical to the calculation. Understanding the difference between variable costs and other costs, such as fixed costs, will allow you to better classify costs correctly. This is known as categorizing costs. Most of the time many of the costs will be easy to recognize, but in some cases it can be more difficult. For example, a sales rep might be compensated with a fixed salary along with a commission that fluctuates with sales performance. In this scenario, the commission would fall into a variable cost category, whereas the salary is fixed.

Total all the variable costs for a specific period after you complete the categorization process. For example, consider our spark plug manufacturing operation that has three different variable costs: materials, labor, and sales commissions. Pretend our incurred costs for last year were $50,000 of raw materials, $30,000 of labor, and $10,000 in sales commissions. The total variable costs for last year would be $90,000 (50,000 + 30,000 + 10,000). These expenses are specifically tied to the production activities for last year.

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