The financial world buzzes with numerous terms, making it seem like a jigsaw puzzle. And for businesses, getting a grip on every term can significantly influence decision-making and growth.
For example, have you ever pondered, “What are variable expenses?”
Well, this is your golden ticket to understanding the intricacies of this vital accounting concept. Fact: businesses that manage their variable and fixed costs efficiently witness higher profit margins. In order to harness this potential, you must be aware of its complexities.
Defining the Core: What Are Variable Expenses for a Business?
Variable expenses are costs that change in proportion to how much a company produces or sells. They are an integral part of budgeting and planning, and a company must be aware that variable costs will also proportionally increase if it plans to double its output next year.
Understanding the difference between fixed and variable expenses gives a clearer picture of where the money is going and how each expense impacts the company.
Examples of variable expenses include labour and raw materials, which change with sales. Other examples of variable expenses in a production setting include direct materials, sales commissions, and credit card fees.
So, why should businesses be in the loop about variable expenses? Simple. By comprehending these costs, businesses can forecast budgets, plan for the future, and make informed financial decisions.
Fixed Vs. Variable: Drawing the Line
Now that we’ve touched upon variable expenses, how do they stand when we define fixed and variable costs in the same breath? While variable costs are like fluctuating tides, fixed costs remain constant regardless of business operations. Think of it this way: even if your business doesn’t sell a single product for a month, you’ll still need to pay the rent for your office space. That rent is a fixed cost.
Crystal Clear with Examples
To illustrate these concepts further, let’s delve into some examples of fixed and variable costs:
Fixed Costs Examples:
- Office Rent
- Salaries of Permanent Staff
- Insurance Premiums
- Lease payments
- Property taxes
- Loan repayments
Variable Expenses Examples:
- Commission for sales staff
- Electricity bills (based on usage)
- Cost of raw materials
- Direct labour
- Manufacturing supplies
- Freight and delivery charges
- Card fees
By classifying costs into these categories, a business can pinpoint areas where they can cut back or need to allocate more resources.
The Formula to Decode Variable Expenses
While it’s pivotal to understand the difference between fixed and variable expenses, it’s equally vital to determine how to calculate the latter. Here’s the formula that businesses commonly employ:
Variable Cost = Total Variable Expense / Total Units Produced
This formula assists in determining the variable cost per unit, providing insights into the cost structure and profitability of products or services.
Putting the Formula to Work
Let’s say a company produces 1,000 units of a product and has a total variable expense of R10,000. We can use the formula to calculate the variable cost per unit:
Variable Cost = Total Variable Expense / Total Units Produced
Variable Cost = R10,000 / 1,000
Variable Cost = R10
Therefore, the variable cost per unit is R10. This means that for each unit produced, the company incurs R10 in variable costs, which include expenses such as raw materials, direct labour, and variable overheads.
How Do Variable Costs Impact Your Bottom Line?
The understanding and management of variable expenses play a key role in profit maximisation. A business that fails to keep these expenses in check might find its profit margins dwindling, even if sales volumes are soaring. Therefore, by keeping an eagle eye on these fluctuating costs and adjusting operations accordingly, businesses stand a better chance of bolstering their bottom line.
What are Some Indicators That My Variable Costs Need to be Adjusted?
There are several indicators that a business needs to address variable costs. Here are some examples:
High variable costs compared to fixed costs
If a business has a high proportion of variable costs compared to fixed costs, it may struggle to maintain profitability during periods of low sales volume. In this case, the business may need to consider reducing variable costs to improve its financial position.
Fluctuations in production volume
If a business experiences significant fluctuations in production volume, it may need to adjust its variable costs accordingly. For example, if production volume decreases, the business may need to reduce its variable costs to maintain profitability.
If a business faces increasing competition, it may need to reduce its variable costs to remain competitive. This could involve finding ways to reduce the cost of raw materials, labour, or other variable expenses.
Declining profit margins
If a business’s profit margins are declining, it may need to review its variable costs to identify areas where it can reduce expenses. This could involve renegotiating contracts with suppliers or finding ways to improve efficiency in the production process.
Inefficient production processes
If a business’s production processes are inefficient, it may be incurring unnecessary variable costs. In this case, the business may need to review its processes to identify areas where it can reduce costs without compromising quality.
By addressing variable costs, businesses can improve their financial position, maintain profitability, and remain competitive in their market.
The Power of Knowledge
Understanding the dynamics of the question, “What are variable expenses” is comparable to having a roadmap for financial planning. By distinguishing between variable and fixed costs, businesses pave the way for more streamlined operations, better budgeting, and, ultimately, higher profitability.
In the world of finance and accounting, knowledge is power. And if you’re seeking tools to enhance your grip on expenses, then you’re in the right place.
Contact the knowledgeable team at Omni Accounts and request a demo of our products or services. Let us partner with you on your journey to financial maturity.