What is a Variable Cost?
In the world of accounting and finance, there are various costs associated with producing and selling a product or service. One of the most important cost classifications is variable cost.
Definition of Variable Cost
A variable cost is a cost that changes in proportion to the level of production or sales volume. In other words, the cost varies with the number of units produced or sold. Variable costs are incurred only when a product or service is produced or sold. Examples of variable costs include direct labor, direct materials, and commissions.
How to Calculate Variable Cost
To calculate variable cost, we need to first identify the cost and the activity that drives the cost. Once we have identified the variable cost, we can calculate it using the following formula:
Variable Cost = Cost per Unit x Number of Units
For example, let’s say a company produces 1,000 units of a product and the variable cost per unit is $10. The total variable cost for producing 1,000 units would be:
Variable Cost = $10 x 1,000 = $10,000
Importance of Variable Cost
Variable cost is an important concept in managerial accounting because it helps businesses understand the cost structure of their products or services. By understanding the variable cost, businesses can make better decisions about pricing, production, and profitability. For example, if a company knows that the variable cost of producing a product is $10 per unit, it can set a price that is higher than $10 to make a profit. Additionally, if a company wants to increase production, it can estimate the additional variable costs that will be incurred.
Another important aspect of variable cost is that it helps businesses determine their contribution margin. Contribution margin is the amount of revenue left over after variable costs have been subtracted. This metric is useful for determining the profitability of individual products or services. By subtracting the variable cost from the sales price, a company can determine the contribution margin per unit. This information can be used to make decisions about pricing, production, and profitability.
Conclusion
Variable cost is an important concept in managerial accounting that helps businesses understand the cost structure of their products or services. Variable cost is a cost that changes in proportion to the level of production or sales volume, and it is incurred only when a product or service is produced or sold. By understanding the variable cost, businesses can make better decisions about pricing, production, and profitability. Additionally, variable cost is important for calculating the contribution margin, which is a useful metric for determining the profitability of individual products or services.
For more information about Fixed Costs and Mixed Costs, visit these articles: Fixed Cost, Mixed Costs, Difference Between Fixed, Variable, and Mixed Costs.