If you want to optimize operations and boost profitability, understanding cost management is a must. One of the more important aspects of cost management is variable cost, as it directly impacts a manufacturing company’s bottom line.
Understanding variable costs helps you make more informed decisions.
In this article, we’ll answer two common questions:
Let’s begin!
A variable cost is an expense that changes in proportion to production or sales volume. This means as production increases or decreases, so does the total cost.
For example, if a company produces more goods, variable costs will rise, and if production decreases, so will the variable cost.
Here are a few examples of variable costs:
Variable costing data provides valuable insights into the interworkings and financial health of the company. It’s used to analyze and optimize expenses, make pricing decisions, and improve profitability.
Let’s take a closer look at some of the reasons why variable cost analysis is important:
Variable costs are critical in determining pricing because they directly impact the cost of producing a product. This opens the door for companies to set prices that not only cover the cost of production but also generate a profit.
There are multiple pricing strategies and concepts that require the calculation of variable costs, including:
By considering variable costs when setting prices, manufacturing businesses can be sure they:
Variable costs play a critical role in creating financial forecasts, making informed business decisions, and ensuring the financial health of a company. This is done through:
Accurate cost projections
Because variable costs directly correlate with production and sales, they are essential for precise cost projections. With accurate cost projections, companies can set more realistic budgets.
Sensitivity analysis
Variable costs are sensitive to fluctuations in sales and production levels. Conducting sensitivity analyses allows businesses to measure how changes in levels affect the overall costs. This enables scenario planning and risk assessment.
Resource allocation
Proper resource allocation is vital for efficient production. Knowing the variable costs helps allocate resources based on potential returns and profits.
Besides these, variable costs impact many other areas related to budgeting and planning, providing essential insights to navigate business uncertainties.
The break-even point determines the level of sales needed to cover all of the costs of production; fixed and variable costs. If a company is at the break-even point, they are neither making nor losing money.
Accurate variable costing plays a role in helping the company determine an accurate break-even point enabling them to set profitable prices.
Variable costs are an integral part of determining margins and net income.
To give you the best explanation of how they tie in, take a look at some of the formulas below:
Gross Profit Margin = (Total Revenue - Cost of Goods Sold) / Total Revenue
Contribution Margin = Sales Revenue - Variable Costs
Net Income = Total Revenue - (Fixed Costs + Variable Costs)
Understanding how variable costs impact margins and net income allows manufacturing companies to optimize profitability.
Because of their direct relationship with production and sales volume, variable costs have a significant impact on a company’s expense structure. Understanding this impact is essential for effective cost management and financial planning.
Variable costs play an integral role in making many of the important decisions for a business. Understanding how variable costs impact the following areas leads to better-informed decisions and improved profitability:
For manufacturing companies, each of these is essential for a successful business. But again, at the root is understanding and accurately calculating variable costs.
The good news is there are powerful tools, like Katana, that were created to help manufacturers and the accountants that serve them calculate variable costs correctly.