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Variable Expenses Definition, Examples, & More
A business can plan for many of its expenses. Fixed expenses, like employee salaries (not including sales commission), software subscription fees, insurance, and advertising, tend to remain the same for long periods of time. But what about costs that change over time, even day to day? These are known as variable expenses, and that’s what we’ll discuss today.
This post will cover what variable costs are, their characteristics, examples of them, and how they differ from fixed expenses.
Variable expenses can significantly impact a company’s profitability and cash flow. We’ll also examine strategies for managing them and how to incorporate them into your budgeting process.
What are Variable Expenses?
Variable expenses are costs that fluctuate with the level of production or sales volume. Unlike fixed expenses, which are constant regardless of output, variable expenses rise and fall in direct proportion to business activity.
For example, if a company produces more products in one month, it will incur higher costs for raw materials and direct labor. The next month, it might produce fewer products, and its variable costs could be lower.
How Variable Costs Differ from Fixed Expenses
Fixed costs, like rent, salaries, and insurance remain constant regardless of the company’s level of production or sales. Or, in some cases, such as insurance, a business will at least have notice of a change in these costs.
Conversely, variable expenses change depending on business activity and other factors.
Knowing the difference between these expenses and how specific business processes affect them is vital for effective financial planning and budgeting. This understanding also aids in pricing, cost control, and profit margin calculations.
How to Spot Variable Expenses
Variable expenses have certain characteristics that help you differentiate them from fixed costs.
Three of the biggest are:
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Fluctuation with Production or Sales Volume
Variable expenses rise with an increase in production or sales and fall when production or sales decline. They are not fixed and tend to be different month to month.
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Direct Correlation to Business Activity
The variability of these costs is directly tied to the business’s operational activities. In this case, an example would be how sales commissions will vary depending on the number of sales made.
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Ease of Adjustment
Businesses have less control over fixed costs than they do variable ones. Fixed costs tend to stay the same throughout the year, which makes them easier to budget. However, because they aren’t directly related to operations or business volume, they are harder to control.
Variable expenses, on the other hand, are more controllable.
Let’s look at some specific examples of variable expenses to demonstrate how businesses can play a part in controlling them.
5 Examples of Variable Expenses
Each of these five types of variable expenses is somewhat within a business’s control.
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Raw Materials
We’ll begin with raw materials—these costs fluctuate directly with the level of production.
Let’s consider a bakery as an example.
If the bakery doubles its order volume in one month, they could spend up to twice as much on products like flour, sugar, and other ingredients, as more goods are baked. Even if they are eligible for a discount for ordering more of a product, it will still cost more than the first month.
In this case, spending more on these products likely isn’t an issue for the bakery because its sales have increased too. If its profit margins are thin, however, the money the bakery makes might not increase as much as what it spends on raw materials.
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Direct Labor Costs
Labor costs can also be variable when workers are compensated based on what they produce or how many hours they work, rather than being paid a salary.
For example, in a manufacturing plant, workers are often paid hourly. If the plant increases its production in one month and requires more labor hours from workers, its labor costs will increase accordingly.
Did you know Xledger offers time and expense functionalities for both employees and managers? Learn more about our time and expense management features.
Similarly, some businesses operate on a piece-rate system, where workers are paid per unit they create. When workers are more productive and their output increases, a plant will then spend more on labor costs. This means labor costs are adaptable to production needs.
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Commissions
Sales commissions are one of the most obvious examples of variable expenses. In this case, payments are made to sales staff based on the percentage of sales they generate.
For instance, if a salesperson earns a 5% commission on each sale, higher sales volumes will result in higher commission payouts.
If they sell $100,000 of product in one month, their commission would be $5,000. But let’s say the next month they increase their sales to $350,000. Now, their monthly commission would be $17,500.
If a business doesn’t account for variation in these costs (in this case, a difference of $12,500), it can face cash flow problems and other issues.
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Utilities
In the same way personal utility usage varies from month to month, utilities for businesses will, too.
Things like gas, water, and electricity are often billed based on consumption. There might also be a monthly fixed cost for these utilities, and then businesses are responsible for paying a certain percentage based on how much they use each month.
In a factory setting, higher production often requires more machinery operation. In turn, this leads to increased electricity usage. During peak production times, the cost of utilities will rise, whereas during slower periods, these costs will decrease.
Utility bills can also vary from season to season, and these are things businesses must plan for with financial forecasts.
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Shipping and Packaging
Finally, we come to shipping and packaging. These are variable expenses because they depend on the volume of goods a business sells and ships in a month.
When, for example, an eCommerce business experiences a sudden rise in sales volume, it will also have higher shipping and packaging expenses.
More sales mean more products need to be packaged and shipped to customers. These costs can include shipping fees, packaging materials, and handling charges.
Fixed Overhead Costs
To better highlight the difference between variable expenses and fixed overhead costs, let’s discuss four identifying characteristics of overhead costs.
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Consistency
Fixed costs don’t fluctuate with the level of production or sales. This consistency allows businesses to have a predictable cost structure and therefore helps make it easier for the business owners or managers to plan and budget.
For instance, a factory could make 100 units in a month or it could make 1,000 units, and still, the cost of rent would be the same. This consistency of this expense can help businesses better manage their finances and provide more stability, especially when sales or production aren’t consistent.
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Long-Term Obligations
Another way to identify fixed expenses is by their long-term nature. This includes expenses like leases, salaries, and loan repayments.
Your business must meet these obligations regardless of how well your business performs. For example, a company may sign a multi-year lease for office space, committing to a fixed monthly rent payment.
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Inflexibility
Again, unlike variable costs, fixed costs are not easily adjustable in the short term. Businesses cannot quickly reduce these expenses in response to declining sales or economic downturns—you typically can’t get a drastic decrease in rent payments on short notice.
Similarly, significantly reducing its executive salaries without significant consequences isn’t easy for a company, either.
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Impact on Break-Even Point
A break-even point for a business is that at which total revenue equals total costs. If these numbers are the same, the company “breaks even.” If the business has more revenue than expenses, the business earns a profit.
In relation to fixed costs, a business must be able to cover these with its sales revenue. That means that higher fixed costs necessitate a higher break-even point.
How to Forecast and Budget for Variable Expenses
Companies can and should budget for variable costs. While these expenses fluctuate, historical data can provide a basis for forecasting.
Budgeting for variable expenses can be challenging, particularly without financial automation software, but it is integral to financial stability.
Here are some strategies to help you forecast and budget for variable expenses:
- Analyze historical data: Look at past trends in your business to see how variable expenses have changed in different production or sales periods.
- Consider external factors: Be aware of any external factors that can impact expenses, such as seasonal fluctuations or economic conditions.
- Use financial automation software: Financial automation software helps you track and analyze spending patterns. This makes it easier to accurately forecast and budget for variations.
- Plan for contingencies: Create a contingency plan for when there are variations in your expenses in—these happen to every business at some point. With a reserve set aside, your business can better weather these changes without serious financial strain.
- Review and adjust: As your business scales, some of your expenses will too. Regularly review and adjust your budget accordingly as you monitor trends in variable expenses.
Variable Expenses: FAQs
Browse these common questions about variable expenses for answers to any lingering questions.
What is a Variable Expense?
A variable expense is a cost that varies directly with changes in the level of production or sales. Unlike fixed (or constant) expenses, variable expenses fluctuate based on business activity.
What are Examples of Variable Expenses?
Common examples of variable costs include:
- Costs for raw materials
- Direct labor costs
- Commissions
- Utilities
- Shipping and packaging costs
Can a Company Budget for Variable Costs?
Yes, but this involves careful financial planning. If a company analyzes historical data, plans for different scenarios, and uses powerful financial software, it can successfully budget for variable expenses.
Manage Your Variable Expenses with Xledger
When managing your business’s finances, account for all expenses, including planned and variable costs. The key is to routinely review these expenses and pinpoint areas where you can implement cost control measures. This is also a great way to be proactive rather than reactive about your expenses.
To take the manual work out of this process and ensure it’s done as efficiently and accurately as possible, turn to Xledger. With robust automation features, your business can automate up to 75% of its processes.
Xledger’s financial management software tracks and forecasts your variable expenses accurately. With our powerful tools and user-friendly interface, we make it easier than ever to control costs, monitor budgets, and plan for the future.
Book an Xledger demo today to find out how managing your company’s variable costs with financial software can improve your bottom line.
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