Variable cost

Definition

Variable costs are direct economic resources that are consumed in production of a particular unit of a product. They are part of the direct costs (sub-set of direct cost). As the name suggests, their monetary value vary with volumes of output. Such that as output volumes increase, the variable cost increase and the vice versa is true. This implies that at zero level of production, the variable cost monetary value is also zero. In a nutshell, there is a direct relationship between the variable cost and the level of output.

NOTE THAT….

1. Variable cost is the cost element of a product that has a behavior of changing such that when the volumes of production change, the cost element change even if not at the same proportions. A good example is packaging materials, direct raw materials and direct labor.
2. As the name suggests, variable cost is a cost element which change with changes in the level of production. Such that, when production is at zero level, variable cost will be zero also. If production increases, the variable cost increases although it may not be at the same proportions.

1.1 Variable Cost Models

1..1.1 Mathematical Variable Cost Model (i.e., formula)

Mathematical Variable cost model is an expression of the relationship between total variable cost and total units produced or manufactured of a particular product using a mathematical formula.

The expression is as follows;

Variable Cost=Quantity produced*Variable Cost per unit

Or

TVC=Q*VC/U

Where;

TVC is total variable cost or what we refer to as variable cost in short

Q is quantity of the commodity produced in a specific period of time

VC/U is Variable cost per Unit produced

1.1.2 Tabular Variable Cost Model

Tabular Variable cost model is an expression of the relationship between total variable cost and total units produced or manufactured of a particular product using a table. 

Table 1.1: Tabular Model (i.e., formula) expression is as follows;

1.1.3 Graphical Variable Cost Model

Graphical variable cost model is an expression of the relationship between total variable cost and total units produced or manufactured of a particular product using a graph.

This is expression is as follows;

OR

Generally, the graphical expression can be presented as below;

Further Clarification

What do we mean when we say variable cost change with changes in the level of production?

The answer to that question is that, as production increases, also cost change. That is;

At zero (0) level of production, the variable cost is at $0

At two unit (2) level of production, the variable cost is at $100

This means that the change in cost due to change in quantity produced of a product is;

This means variable cost changes by $100, when production increases from zero (0) to two (2) units. So, when we say variable cost varies, we refer to a change which is more than zero.

Even when the production level reaches four units the change in cost increases further. That is, increases from 100 to 150. Therefore, the change in cost will be;

Advantages Of Variable Cost

1. Controllable

   Variable costs have a characteristic of being flexible and as a result the producer can plan on how much output to be produced.

2. Useful in Break-Even modelling process

   Break-even analysis model is a key decision-making model for most managers and it entails variable cost.

3. Yard stick for pricing of goods and services. Based on the movement of the variable cost, the producer can be in a position to set prices for the goods being produced.
4. Allocation of resources in production schedule

   It is possible to do optimal allocation of economic resources when variable cost behavior is well monitored over time. This avoids resource wastages.

Disadvantages Of Variable Costs

1. Results to cash flow shortages

   If no proper planning, more and more usage of variable cost elements, just like any other resource will result to cash outflow from the business which may make the firm face some financial difficulties.

2. Not commonly accounted for by the small and medium enterprises and this makes this element of cost less popular amongst the small firms.