Table of Contents
- Compute total variable cost
- Examples of variable costs
- Total variable cost curve
- Why total variable cost matters
What’s it: Total variable cost is the sum of all variable costs. Suppose you have data on variable costs per unit. In that case, you can calculate this by multiplying by the quantity to get the total variable cost figure.
Variable cost varies with the number of output produced. If output increases, it increases. And vice versa, If output decreases, it decreases. At zero production, the total variable cost is always zero.
Compute total variable cost
To calculate total variable cost, you must add up each firm’s variable costs. If, in a case, you find the variable cost per unit, then to calculate the total, you multiply it by the total output. Here is the formula:
Total variable cost = Variable costs per unit x Total output
Say, the company reports a variable cost of $50 to make one unit of product. If the company’s total production is 30 units, the total variable cost is $1,500 ($50 x 30).
In other cases, you may have to add up the variable costs of each type. Say, when it produces 100 units of product, the company reports the cost per unit as follows:
- Direct material cost per unit: $10
- Direct labor cost per unit: $14
- Overhead cost per unit: $8
From this data, you first need to add up all these variable costs and get $32 per unit variable costs ($10 + $14 + $8). Then, you multiply the result by the total output to get the total variable cost, which is $3,200 ($32 x 100 units).
In other cases, you may find total costs and total fixed costs. To calculate total variable cost, you can subtract total fixed costs from total costs.
Total variable cost = Total costs – Total fixed costs
Examples of variable costs
Variable costs vary between industries. But, to be sure, they only cover those costs that increase (decrease) in response to an increase (decrease) in production or sales volume. In manufacturing, the elements of the total variable cost usually consist of:
First, direct raw material costs. Raw materials make up the finished product and can be traced to specific manufacturing activities.
Thus, when production increases, companies need more raw materials. Conversely, when production decreases, companies need less raw materials. Companies do not need raw materials when closing factories or stopping production.
Second, logistics costs. When increasing production, the company transports more raw materials to the production facility. Conversely, a decrease in production reduces the delivery of raw materials.
Third, piece rate. The company may employ temporary workers to help with the production process. They help some permanent workers to operate machines or other production activities.
Companies are hiring more temporary workers to increase production when they meet spike orders. However, during normal production, they only use permanent employees and do not require temporary workers.
As a note to you, some direct labor types may not be considered an element of total variable cost because they rarely change directly to production volume.
Furthermore, in a service firm, direct labor costs are variable costs because they vary directly with the firm’s number of services.
Other examples of variable costs are:
- Packaging costs
- Shipping cost to the customer
- Sales commission
- Utility costs associated with production activities
Total variable cost curve
As I have mentioned, variable costs change in proportion to the production output. They decrease or increase depending on the production volume of the company. They rise when production increases and falls when production decreases.
Meanwhile, fixed costs do not change regardless of the firm’s output. Whether making sales or not, the company has to bear fixed costs. In other words, we say fixed costs are independent of output.
Examples of fixed costs are machine rental, vehicle rental, and office supplies. The company still has to pay rent for the vehicle, regardless of whether they operate it or not.
Thus, if we plot it on a graph, the total cost curve moves up as the output increases. When production is equal to zero, the value is also zero.
Conversely, because it does not change, the total fixed cost curve remains horizontal. When production equals zero, the company must pay a fixed cost so that the value will not equal zero, as in the picture above.
Furthermore, the total cost curve will also increase according to the total variable cost curve. Remember, the total is equal to total variable cost plus total fixed costs. Since fixed costs do not change, the total cost curve will follow the average variable cost curve.
Why total variable cost matters
First, we use it in the breakeven analysis. The breakeven point occurs when total revenue equals total production costs. From the analysis, we can then determine the sales volume and price. Here is the formula for both:
Break-even volume = Fixed costs / {(Sales revenue – Variable costs) / Units sold}
Break-even price = Total fixed costs / units sold) + variable costs per unit
Second, we use it to calculate the contribution margin. It is useful for measuring how much revenue can cover variable costs. A high contribution margin shows you the company is making significant amounts of money, paying fixed costs and profit.
The following is the contribution margin formula:
Contribution margin = [Quantity x (Selling price – Variable cost per unit)] / (Quantity x Selling price)
Third, companies use variable cost information to support efficiency and profit margins. From the contribution margin formula above, you can see, the lower the variable cost per unit, the higher the contribution margin. For example, to get lower raw material prices, companies can buy in bulk for a discount. Or, the company can acquire a supplier and integrate it into its existing business.