Common Variable Cost Categories in Bookkeeping

When doing bookkeeping, it's important to understand variable costs so that you can handle your money well. Costs that change depending on how much is being made or sold are called variable costs. Variable costs can have a big effect on a company's cash flow and profits, unlike set costs that don't change no matter what the business does. This piece will talk about some common types of variable costs, what they mean for businesses, and how to handle them well.

What Are Variable Costs?

There are costs that change directly with the amount of production or sales. These are called variable costs. These costs are important for companies that make things or offer services because they have a direct effect on the cost of goods sold (COGS) and the general profit of the company. For planning, forecasting, and financial analysis, it's important to understand variable prices.

Key Characteristics of Variable Costs

• Directly Linked to Production: Variable costs increase as production increases and decrease as production decreases.

• Fluctuating Nature: These costs can vary significantly from month to month, depending on sales volume and operational activity.

• Impact on Profitability: Managing variable costs effectively can lead to improved profit margins and better cash flow management.

Common Variable Cost Categories

Business owners can better handle their money if they know about the different types of variable costs. Here are some common types of changeable costs:

1. Direct Materials

The raw materials that are used to make things are called direct materials. These costs change depending on how much is being made because they are directly related to the producing process. For instance, the cost of wood, cloth, and hardware for a furniture maker will depend on how many pieces they make.

Example:

If a company produces 100 chairs and each chair requires $20 worth of materials, the total direct material cost would be:

Direct Material Cost =Number of Chairs x Cost per Chair

Direct Material Cost = 100 x 20 = 2000 

2. Direct Labor

The wages paid to workers who do direct work in making things or providing services are called direct labor costs. The amount of work done and the number of hours spent can change these costs. In a workplace, for example, where workers are paid by the hour, the total cost of labor will go up as production goes up.

Example:

If workers are paid $15 per hour and work 40 hours to produce 100 units, the direct labor cost would be:

Direct Labor Cost = Hourly Rate x Hours Worked

Direct Labor Cost = 15 x 40 = 600 

3. Manufacturing Overhead

Overhead costs in manufacturing are all the costs that aren't directly linked to a specific product but are still part of the production process. This could include things like utilities, repairs, and the wear and tear on tools. Some overhead costs stay the same, but a lot of them change depending on how much is being made.

Example:

If a factory incurs $1,000 in utility costs during a month when it produces 500 units, the variable portion of manufacturing overhead can be calculated based on production levels.

4. Sales Commissions

Sales fees are costs that change based on how many sales are made. Most of the time, salespeople get paid a fee based on how many items they sell. This cost is directly linked to how well sales are going and can change a lot.

Example:

If a salesperson earns a 10% commission on sales and sells $50,000 worth of products in a month, the commission cost would be:

Sales Commission = Sales Amount x Commission Rate

Sales Commission = 50,000 x 0.10 = 5,000 

5. Shipping and Delivery Costs

You have to pay different amounts for shipping and delivery depending on how many items you ship and sell. Different things, like distance, weight, and shipping method, can change these prices. Keeping these prices under control is important for keeping profit margins high.

Example:

If a company incurs $200 in shipping costs for 100 orders, the variable shipping cost per order would be:

Shipping Cost per Order = Total Shipping Cost / Number of Orders

Shipping Cost per Order = 200 / 100 = 2 

6. Inventory Costs

Costs of inventory can also be thought of as changeable costs, especially for companies that keep stock. The price of buying inventory, the cost of storing it, and any costs related to keeping track of inventory amounts are all part of these costs. The cost of goods will go up as sales go up.

Example:

If a retailer purchases $5,000 worth of inventory to meet demand and sells it, the inventory cost will directly impact the COGS.

Read More: Controlling Variable Expenses During Low Revenue Months

Read More: FIFO vs LIFO Which Method Affects COGS More

Managing Variable Costs Effectively

Managing variable costs is essential for maintaining profitability and ensuring financial stability. Here are some actionable tips for effectively managing variable costs:

1. Monitor Costs Regularly

Regularly tracking variable costs can help identify trends and areas for improvement. Accounting software can help you keep track of your spending automatically and make reports that show you how your changeable costs change over time.

2. Negotiate with Suppliers

You can get better prices and terms from providers if you have good relationships with them. Review your contracts with suppliers on a regular basis and try to get lower prices on things like raw materials and other costs that change.

3. Optimize Production Processes

Streamlining production processes can help cut down on the costs of direct labor and other factory overhead. Using the ideas of lean production can help make things more efficient and cut down on variable costs.

4. Implement a Budgeting System

Businesses can prepare for changes in costs by making a budget that includes fluctuating costs. A flexible planning method lets changes be made based on how well the plan is working.

5. Analyze Profit Margins

Look at the profit margins on a regular basis to see how changing costs affect the general profit. This study can help you find places where you can cut costs without lowering quality.

Common Questions About Variable Costs

What is the difference between variable costs and fixed costs?

Variable costs change depending on how much is being made, while set costs stay the same no matter how much is being made. Understanding this difference is important for making good budgets and plans for your money.

How can I reduce my variable costs?

To lower variable costs, you could negotiate with suppliers, make production methods more efficient, and look over your expenses on a regular basis to find ways to cut costs even more.

Why are variable costs important for my business?

Variable costs are important for figuring out how much something really costs to make and for making smart decisions about price and budgeting. Keeping these prices under control can help a business make more money.

How does bookkeeping help in managing variable costs?

Bookkeeping is an important part of keeping correct records of variable costs. A good system for keeping books makes sure that all of your spending is recorded correctly. This makes it easier to look at your costs and make smart financial choices.

Conclusion

For good bookkeeping and money management, you need to know about the typical types of variable costs. Businesses can make more money and stay financially stable by understanding the different kinds of unpredictable costs and coming up with ways to handle them.

If you find managing your variable costs overwhelming, consider partnering with Irvine Bookkeeping. Irvine bookkeeping services can help you streamline your financial management, ensuring accuracy and saving you time. Let us handle the numbers while you focus on growing your business!