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This article was co-written by Madison Boehm. Madison Boehm is a business consultant and co-founder of Jaxson Maximus, a menswear and beauty salon in southern Florida. She specializes in business development, operations and financial management. In addition, she has experience in cosmetology, apparel and retail. Mandison holds a bachelor’s degree in business administration in entrepreneurship and marketing from the University of Houston.
There are 9 references cited in this article that you can view at the bottom of the page.
This article has been viewed 53,721 times.
Expenses related to business activities are usually divided into two categories, namely variable costs and fixed costs. Variable costs are costs that fluctuate with the volume of production, while fixed costs remain the same. Understanding how to classify expenses is the first step for you to manage and improve business efficiency. In particular, knowing how to calculate variable costs will help you reduce the costs incurred for each unit of production, helping your business to make more profits.
Steps
Calculate variable costs
- After understanding the difference between fixed and variable costs, start categorizing the costs of each business. Many costs, such as in the example mentioned above, are fairly easy to categorize. But there are also a lot of costs that can be quite obscure.
- Some costs can be difficult to categorize, with no obvious fixed or variable pattern. For example, an employee may be paid a fixed salary along with a commission that varies with sales volume. These costs are divided into fixed and variable elements separately. In this case, only the employee’s commission will be treated as a variable cost. [2] X Research Source
- Imagine the costs incurred in the most recent year include: $35,000 – raw materials, $20,000 – packaging and shipping, and $100,000 – employee wages.
- Total variable costs for that year are 35,000 won+20,000 won+100,000 won{displaystyle 35,000+20,000+100.000} , it mean $155,000 won{displaystyle $155,000} . This cost is directly related to the output produced in that year.
- Unit variable cost is simply the variable cost per unit produced. It is the cost incurred when producing an additional unit. For example, if the above business produces 100 more units, it will incur additional production costs of $31. [4] X Research Sources
Use the maximum-minimum method
- An example of a mixed cost is the cost of wages for an employee with salary plus commission. Wages are paid even without sales, but commissions depend on sales volume. In this example, commissions are variable costs and wages are fixed costs. [5] X Research Sources
- Mixed costs may also apply to hourly payees if they are guaranteed a fixed number of hours per pay period. Regular hours will be a fixed cost, and any overtime hours will be a variable cost.
- In addition, employee benefit costs can be recognized as mixed costs.
- Another more complex example of mixed costs is utility costs. Whether you produce or not, you still have to pay for electricity, water, and gas. However, electricity, water, and gas usage can increase as production increases. To divide this cost into fixed and variable costs requires a more complex method.
- For example, imagine your company uses a water cutter to cut metal as part of the manufacturing process. Water is required to do this, and water is a variable cost, which increases with the volume of production. However, water costs at your company also arise from operating the production facility (such as for drinking, cleaning, etc.). Thus, the cost of water is a mixed cost.
- Also in this example, the month with the highest water bill is $9,000 with 60,000 man-hours of production. And the month with the lowest water bill is $8,000 and 50,000 man-hours of production.
- According to the example above, DRAWOLDCHEAP=$9,000 won−$8,000 won60,000 won−50,000 won{displaystyle VCR={frac {$9,000-$8,000}{60,000-50,000}}} . i.e DRAWOLDCHEAP=$1,000 yen10,000 won{displaystyle VCR={frac {$1,000}{10,000}}} , get 0.10 USD. This means the production cost of each overtime hour is $0.10. [7] X Research Sources
Using variable cost information
- To determine if variable costs are stable, divide total variable costs by revenue. Through this result you can see how much variable costs account for how much. You can then compare this number with previous variable cost data to see if your variable costs per unit increase or decrease. [9] X Research Source
- For example, if total variable costs are $70,000/year and $80,000 in the following year while revenue is $1,000,000 and $1,150,000 respectively, you can see from the above figure that variable costs change remained fairly stable during those two years at $70,000 won÷$1,000 yen,000{displaystyle $70,000div $1,000,000} , ie 7{displaystyle 7} % of sales in the previous year, and $80,000 won÷$1,150,000 won{displaystyle $80,000div $1,150,000} , or 6,96{displaystyle 6.96} % of sales in the following year).
- If a company has mainly variable costs in production, it may have a more stable cost per unit. Since profit flow is also more stable, we are assuming stable sales.
- This is true of major retailers like Walmart and Costco. Their fixed costs are relatively low compared to their variable costs which account for a large proportion of the costs associated with per-unit sales. [10] X Research Source
- However, a company with a higher fixed cost ratio may be more likely to take advantage of economies of scale (larger production leads to lower costs per unit) as sales grow faster. much more than the cost.
- For example, a computer software company has fixed costs associated with product development and support staff, but it can expand its software sales without incurring significant variable costs.
- As revenue declines, a company that relies heavily on variable costs can easily scale back production and still be profitable, while a company that relies heavily on fixed costs will have to find ways to deal with much higher fixed costs per unit. [11] X Research Source
- A company with high fixed costs and low variable costs also has production leverage that increases or decreases profits, depending on sales. Essentially, sales above a certain level are more profitable, while sales below this level are much more costly.
- Ideally, the company should try to balance risk and return by adjusting fixed and variable costs.
- A higher-than-average variable cost per unit indicates that the company is using a larger amount or spending more on resources (labour, materials, utilities) to produce goods than its competitors. their competition. This could be due to low efficiency or high cost resources. And either way, the company is not as profitable as its competitors, unless it can reduce its costs or raise it higher.
- On the other hand, if the company has the ability to produce the same good at a lower cost, it will realize a competitive advantage by being able to reduce the cost in the market.
- This cost advantage can be attributed to cheaper resources, cheaper labor or greater production efficiency.
- For example, a company can buy cotton yarn at a lower price than its competitors, so it can produce shirts at a lower variable cost and, of course, a lower selling price.
- Trading companies usually publish their financial statements on their websites or the Securities and Exchange Commission (SEC). You can find information on variable costs through their income statement.
- For example, if your company plans to produce a new product with an initial investment of $100,000, and you want to know how much of that product you need to sell to get your investment back and make a profit. . You subtract the sum of the investment costs plus the other fixed costs plus the variable costs from the revenue at different levels of production.
- You can calculate your breakeven point using the following formula: Q=FP−v{displaystyle Q={frac {F}{Pv}}} . In the above formula, F and v are the fixed and variable costs per unit, respectively, P is the selling price of the product, and Q is the breakeven amount. [14] X Research Source
- For example, if the other fixed costs in the production process are $50,000 (plus the initial $100,000 investment for a total fixed cost of $150,000), the variable cost per unit is $1. and each product sells for $4, we have a breakeven point of Q=$150,000 won$4−$first{displaystyle Q={frac {$150,000}{$4-$1}}} , the result is 50,000 units.
Advice
- Note: the example calculation formula and formula above can be applied to other currencies.
This article was co-written by Madison Boehm. Madison Boehm is a business consultant and co-founder of Jaxson Maximus, a menswear and beauty salon in southern Florida. She specializes in business development, operations and financial management. In addition, she has experience in cosmetology, apparel and retail. Mandison holds a bachelor’s degree in business administration in entrepreneurship and marketing from the University of Houston.
There are 9 references cited in this article that you can view at the bottom of the page.
This article has been viewed 53,721 times.
Expenses related to business activities are usually divided into two categories, namely variable costs and fixed costs. Variable costs are costs that fluctuate with the volume of production, while fixed costs remain the same. Understanding how to classify expenses is the first step for you to manage and improve business efficiency. In particular, knowing how to calculate variable costs will help you reduce the costs incurred for each unit of production, helping your business to make more profits.
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