Variable costs

Costs that change in proportion to sales are variable costs. Common variable costs include raw materials, shipping and depletion.

The opposite of variable costs are fixed costs. In between are semi-variable costs that have fixed and variable elements.

A high level of variable costs means a low level of operational gearing.

It can be useful, for financial modelling, to estimate the level of variable costs. These are management accounting numbers that are not usually directly disclosed, so there will always be some uncertainty.

The simplifying assumption that variable costs vary directly in proportion to sales or production is usually accurate enough, however, do be aware that this ignores economies of scale and other effects that can change costs with scale.

When modelling over long periods of time, it may be that a company may scale its business up or down (e.g. building or closing factories), so fixed costs may vary.

Although most cost of goods sold is variable, and a high proportion of sales, general and administrative costs are fixed, the correspondence is far from perfect — it should be obvious that sales costs will usually have a high proportion of variable elements.

Copyright © 2005-2016