A variable cost is a business expense that fluctuates with the volume of goods or services produced. Variable costs are often referred to as volume-dependent costs.
Characteristics of variable costs:
- Directly relate to the level of production or number of units sold. They change in direct proportion to changes in volume.
- Include costs of direct materials, direct labor, commissions, transportation, royalties, and certain types of production overhead.
- Tend to be short-term in nature since they are activity-based and often easy to control or adjust.
- Per unit variable costs typically decline with increased production volume due to leverage of factory overhead.
- Allow breakeven analysis to determine sales volume needed to cover variable costs of production.
- Fluctuate independently of fixed costs which do not change with volume and must be covered.
- Are deducted from revenue to determine contribution margins and profitability.
By definition, variable costs are variable rather than fixed regarding production and sales activity levels.