Variable costs

What it means

Variable costs rise and fall with volume: materials, goods, freight, sales commissions, payment gateway fees, output-linked wages.

The difference from fixed costs lies in behaviour, not category. The same item can be fixed in one company and variable in another, depending on how it is contracted.

Variable costs are often confused with direct costs. A direct cost can be traced to a specific product or job, a variable cost moves with volume: a licence bought for one job is direct but fixed, while energy in the production hall is variable even though it is not traced to a unit. Costing needs to track both.

How it works in practice

Knowing variable cost per unit is the precondition for contribution margin and the break-even point. Without it prices are set by feel and discounts given blind.

The books can separate them by analytical accounts or cost centres. For an online shop returns, packaging and delivery belong in there, or the margin looks better than it is.

In services, such as a marketing agency or an IT firm, variable costs are mostly external subcontractors and freelancers on specific projects. When evaluating a job we therefore tie them to the project through analytical accounts or a cost centre, so it is clear which jobs actually make money.

What to watch out for

As volume grows some variable costs move in steps: the carrier offers a better rate but the warehouse needs another shift. So the costing is revisited at every significant jump.

Salaries of staff on fixed pay are often treated as variable when a job is costed, although they will not fall when orders drop. The company then believes a lower volume saves more than it really does, and the loss arrives sooner than the budget suggested.