Does variable cost per unit remain constant?
Variable cost per unit remains constant i.e., it does not increase or decrease concerning the increase or decrease of goods or services produced or sold.
To illustrate, let’s assume that the variable cost of producing a muffin is $15. Now, let’s assume It’s of production increases to $30, and 2 muffins are produced. Further, the production increased to 10 muffins and the cost per unit rises to $150. On observing, we find that even though the its cost changed as the production of muffins changed, the variable cost per unit remains constant i.e., $15 (Cost of production/No. of units produced).
How Is It Calculated?
The formula for calculating-
Total Quantity of Output X Variable Cost Per Unit of Output
To illustrate, let the number of muffins produced be 1,000 and the cost of producing one muffin is $35, then the total variable cost will be $35,000 (1000*$35)
What Is The Significance?
It plays an important role in determining how profitable a business can get. It helps in the decision-making process. If it fluctuates rapidly to the changes in the production or sales level it exhibits an alarming situation. To reach a profitable situation revenue must increase faster than variable costs.
Difference Between The Two Costs
It varies as per the production level of goods or services, whereas fixed cost is the cost that does not change concerning the change in the level of production of goods or services. If production slows down, the variable costs will reduce but the fixed costs will remain constant. Examples of fixed costs include depreciation, lease rental, amortization, interest expense, insurance, etc.
How Can Variable Costs Be Used To Gain An Advantage In Business?
There are two types of costs: fixed costs and variable costs. Also, another type of cost is semi-variable cost. It remains constant (fixed) up to a particular level of production and beyond such a level, such cost starts to fluctuate and takes the shape of a variable cost. Fixed costs are stringent and cannot be changed as per the requirement. It remains constant and thus managers focus on changing variable costs to attain an advantageous position. As it fluctuates, managers can try reducing them when a situation requires them, expenses such as raw materials, direct overheads, and direct labor can be adjusted as required. When such adjustments are made, the contribution per unit (sale price per unit less variable cost per unit) increases, and thereby profits tend to increase.
Variable Cost And Economies Of Scale
Economies of scale play an important role in determining the profitability of a business. Economies of scale mean that as the production of goods increases, the per-unit cost of manufacturing the goods decreases. Thus, as the production level increases, the variable costs-per-unit simultaneously decreases. Large corporations try to achieve economies of scale as it leads to a decrease in the cost of production and an increase in profitability.
Variable Cost And Break-Even Point
The Break-even point is the level of production at which the cost incurred by a business is equal to the revenue. Beyond this point, a company starts to earn positive profits. It takes into account variable cost as it influences decision-making and helps in determining the cost price and sale price of a product. Thus, fixed cost plays an important role in determining the break-even point.
Break-Even Point = Fixed Cost/ Contribution per unit (i.e., sale price per unit – variable cost per unit).
To illustrate, let the fixed cost of producing a muffin be $1700 and sale price be $30 per unit and the variable cost per unit be $25.
Thus, the break even-point here will be 340 units [$100/($200-$50)]. Therefore, to break even, 340 units of muffins should be sold.
Can Variable Costs Be zero?
Yes, variable costs can amount to zero. As It is dependent on the production or sales of goods and services, it varies as per the changes in the level of production or sales of goods and services. If the production level reaches zero then the variable expense will also be zero.
Conclusion
Variable cost changes concerning the changes in the production or sales level. It does not remain constant. It plays an important role in decision-making as it helps in determining the profitability of a business. By changing the amount of variable expenses, the profit level changes. They should be regularly monitored as they can provide insights into the operating cash flows of the business.
