Variable cost

Variable costs are costs that change in proportion to the good or service that a business produces. Variable costs are also the sum of marginal costs over all units produced. They can also be considered normal costs. Fixed costs and variable costs make up the two components of total cost. Direct costs, however, are costs that can easily be associated with a particular cost object. However, not all variable costs are direct costs. For example, variable manufacturing overhead costs are variable costs that are indirect costs, not direct costs. Variable costs are sometimes called unit-level costs as they vary with the number of units produced.

Direct labor and overhead are often called conversion cost, while direct material and direct labor are often referred to as prime cost.

In marketing, it is necessary to know how costs divide between variable and fixed. This distinction is crucial in forecasting the earnings generated by various changes in unit sales and thus the financial impact of proposed marketing campaigns. In a survey of nearly 200 senior marketing managers, 60 percent responded that they found the "variable and fixed costs" metric very useful.

The level of variable cost is influenced by many factors, such as fixed cost, duration of project, uncertainty and discount rate. An analytical formula of variable cost as a function of these factors has been derived. It can be used to assess how different factors impact variable cost and total return in an investment.

Assume a business produces clothing. A variable cost of this product would be the direct material, i.e., cloth, and the direct labor. If it takes one laborer 6 yards of cloth and 8 hours to make a shirt, then the cost of labor and cloth increases if two shirts are produced.

The amount of materials and labor that goes into each shirt increases in direct proportion to the number of shirts produced. In this sense, the cost "varies" as production varies.

For example, a firm pays for raw materials. When activity is decreased, less raw material is used, and so the spending for raw materials falls. When activity is increased, more raw material is used, and spending therefore rises. Note that the changes in expenses happen with little or no need for managerial intervention. These costs are variable costs.

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