Variable Cost

Definition

In accounting, a variable cost is an expense that changes in direct proportion to your business's production or sales volume. What this basically means is that as you produce or sell more, these costs increase; if you produce or sell less, they decrease.

Examples of variable costs include:

• Raw materials: Naturally, the more products you make, the more materials you need.
• Direct labor: If your workers are paid based on the number of units they produce, when production levels change, this cost will vary.
• Sales commissions: If your sales team earns a commission per each sale, this expense rises as more sales come in.
• Shipping costs: Having more sales often means that you've got more products to ship to customers, which inevitably increases shipping expenses.

Why it matters

Variable costs matter because they’re tied to how much you actually produce or sell, which makes them a key part of managing profits. When a company knows their variable costs, they can predict how much their total expenses will grow or shrink as the company changes. For example, if you’re making more products or seeing higher sales, you know your variable costs will go up, and that affects your overall budget.

When businesses know and understand the variable costs involved, they can confidently set pricing, budget more effectively, and plan for growth. Knowing these costs also allows you to figure out your "break-even point"—the point at which sales cover both your variable and fixed costs.