Sound planning, budgeting, and forecasting significantly impact an organization’s survival, potential growth, and profitable tenure. These inevitably significant processes are the ones that enable an organization, at large, to set the KPIs, their short- and long-term goals, and ultimately the propensity to make an informed decision.
A budget is a carefully thought-out roadmap that an organization is expected to abide by with the intention to achieve the set goal. A lot goes into curating an ideal budget. One needs to crucially scrutinize the organization’s cash flow, its current financial position, and other critically material past records.
Variable Costs and their Importance
Variable costs refer to the direct costs and variable overhead incurred during the production or manufacturing of a product or service, excluding all fixed costs. They specifically pertain to costs that are directly influenced and affected by changes in production.
Management plays a crucial role in actively managing these costs, as fixed costs have already been incurred and cannot be reversed. Therefore, these costs require direct involvement and attention from management.It enables cost-volume-profit (CVP) analysis and break-even analysis by determining the contribution margin which improves resource allocation by the business. Now, to know these things you or your accountant must know to calculate variable cost per unit, and a variable costing income statement.
How to find Variable cost per Unit?
Understanding the variable costs per unit formula and its applications can help businesses make informed decisions about pricing, production, and profitability. By calculating the variable costs per unit, businesses can determine the minimum price they need to charge to cover their costs and make a profit.
For example, if your company sells sets of plates for $400 but each set requires $250 to create, test, package, and market, your variable cost per unit is $250.
Variable Costs Formula
The formula for calculating variable costs is straightforward. You need to multiply the variable cost per unit by the number of units produced or sold. Here is the formula:
Variable Costs = Variable Cost per Unit x Number of Units
For example, if a company produces 10,000 units of a product with a variable cost per unit of $10, its variable cost would be:
Variable Costs = $10 x 10,000 = $100,000
A Variable Costing Income Statement
A variable costing income statement is a financial report in which you subtract the variable expenses from revenue, resulting in a contribution margin. The contribution margin is the incremental profit earned when a product’s sales exceed its variable costs.
Variable Costs and its impact on Budget
1) Business activity independent
Variable costs are directly connected to the production activities such as raw materials, energy, temporary labor costs, or leased employees needed to manufacture products. The Schematic below shows roughly how the total costs increase with the number of units (Or product quantity). This information is often useful to “Price” the product.
2) Time-wise adaptability
Variable costs can vary and are dependent on time since they are directly related to the manufacturing of the products. Note that, if you extend your time frame, all costs including fixed costs become variable in theory. Why? Because you can find “better deals”, high rent vs. low rent, or high salaries vs. low salaries.
Ways to reduce the impact of variable expenses on your budget:
1. Determine the annual average for each variable expense in your budget
While determining the annual average for the variable expense, instead of looking into the last 12 months’ figures, take into consideration the average of 3 years’ worth of expenses. This will help you account for anomalies that may impact your variable expenses.
2. Add a buffer
After you have determined the average for each variable expense, add a buffer to it. A buffer of 3% to 5% should be more than enough to cover your price increases and anomalies that might result in an outlier year for the expense.
3. Track your actual spending
Compare your actual expenditure for each variable expense to the budgeted amount. Look for the areas where the expenditure went over budget or under budget for each expense category.
4. Set up a savings account for variable expenses
This is a crucial step in this process. Each month the actual expenses are under budget for any variable expense, move the excess into a savings account for variable expenses. This will create a reserve you can draw from during months when your expenses are higher than usual.
5. Reassess variable expenses annually
It is important to resist the temptation of using the same variable expenses projections in the budget each year, even if there is a substantial amount in the variable expenses savings account. Following such a practice is highly erroneous. It is crucial to reassess variable expenses regularly, particularly those that can be controlled more effectively.
In conclusion, variable costs are an essential aspect of any business operation. Understanding the concept of variable costs is vital for businesses to make informed decisions regarding their pricing, production, and overall financial health.
Variable costs vary based on the level of production, and this makes them different from fixed costs, which remain constant regardless of production levels. The formula for calculating variable costs per unit is relatively straightforward and can help businesses in determining the cost of producing each unit of their product.
By identifying and analyzing variable costs, businesses can effectively manage their expenses, increase their profit margins, and remain competitive in their respective industries. By implementing effective cost management strategies, businesses can reduce their variable costs and increase their bottom line.
Unison Globus is committed to helping businesses of all sizes manage their finances, including their variable costs. Our team of experienced professionals provides a range of accounting and financial services designed to help businesses reduce costs, increase revenue, and grow their operations. Contact us today to learn more about how we can help your business succeed. Want to outsource accounting or bookkeeping services for your business? Get a trial of our services now.