How to identify variable costs in financial statements

Understanding variable prices is important for any business that wants to keep its finances in order. These costs change based on how much you're making and can have a big effect on your overall profits. We will talk about how to find variable costs in financial records, why they are important for cost analysis, and how they can affect the decisions you make for your business.

What are Variable Costs?

Some costs change directly with the amount of production or sales. These are called variable costs. Variable costs go up when production goes up and down when production goes down. Fixed costs stay the same no matter how much is produced. Here are some common examples of changeable costs:

• Raw Materials: The cost of materials used in the production of goods.

• Direct Labor: Wages paid to workers who are directly involved in the manufacturing process.

• Sales Commissions: Payments made to sales staff based on the volume of sales.

Why is Identifying Variable Costs Important?

1. Cost Control: Knowing about changeable costs helps companies better track their spending, which makes budgeting and planning easier

2. Pricing Strategy: To set competitive prices and make sure you make money, you need to know your changeable costs.

3. Break-even Analysis: Identifying variable costs is essential for conducting a break-even analysis, which helps determine the sales volume needed to cover costs.

How to Identify Variable Costs in Financial Statements

A methodical approach is needed to find variable costs in financial records. To help you find these costs more accurately, follow these steps:

Step 1: Review the Income Statement

The income statement shows how much money the business made and how much it spent over a certain time period. Look for the following to find changeable costs:

• Cost of Goods Sold (COGS): Costs that change during production, like raw materials and direct labor, are usually listed in this part.

• Sales Commissions: If your company gives commissions based on how much you sell, these are also changeable costs.

Step 2: Analyze Expense Categories

In your financial statements, look over more than just the income statement. Look over the specific expense categories as well. Here's how to sort your expenses:

• Direct Costs: These are often variable costs, including raw materials and direct labor.

• Indirect Costs: While these are typically fixed, some indirect costs may have variable components, such as utilities that increase with production levels.

Step 3: Use Cost Behavior Analysis

Cost behavior analysis helps you figure out how prices change as the amount of production changes. In order to do this analysis:

• Identify Fixed and Variable Costs: Set your costs apart into two groups: set and variable. Variable costs change as production does, while fixed costs stay the same.

• Create a Cost Structure: Make a cost plan that shows how each cost changes based on the amount of production.

Step 4: Consult with Your Accounting Team

Engage with your accounting team to gain insights into cost classifications. They can provide valuable information on how costs are categorized and help clarify any ambiguities.

Step 5: Utilize Accounting Software

A lot of accounting software has tools that make it easy to group expenses into different categories. Using these tools will make it easier to find and keep track of changeable costs.

Read More: Variable Cost - Definition, Example, and Guide to Reduce

Best Practices for Managing Variable Costs

1. Implement Cost Tracking Systems

Utilize accounting software to track variable costs effectively. This will help you maintain accurate records and provide insights into your cost structure.

2. Regularly Review Costs

Conduct regular reviews of your variable costs to identify trends and areas for improvement.

3. Train Your Team

Make sure everyone on your team knows how important it is to correctly classify costs. Cost management training can help people do a better job of entering data and making financial reports. If your team knows what they're talking about, they can help you find changeable costs more easily.

4. Optimize Production Processes

To cut down on variable costs, look for ways to make output more efficient. Investing in better technology, streamlining work processes, or negotiating better rates with raw material providers are some ways to do this.

5. Collaborate with Financial Advisors

Make sure that your cost allocation methods are correct and that your financial statements accurately show how your business is doing by working closely with your accountant or financial expert. They can help you understand how changing costs affect your general financial health.

Example of Identifying Variable Costs

Let’s consider a hypothetical manufacturing company, ABC Widgets, which produces custom widgets. Here’s how they might identify their variable costs:

Income Statement Review: ABC Widgets reviews its income statement and finds that the Cost of Goods Sold (COGS) is $200,000. This includes $150,000 for raw materials and $50,000 for direct labor.

Expense Categorization: Upon further analysis, they categorize their expenses:

• Direct Costs: Raw materials ($150,000) and direct labor ($50,000) are identified as variable costs.

• Indirect Costs: Rent and utilities are classified as fixed costs, but they notice that utility costs increase with higher production levels, indicating a variable component.

Cost Behavior Analysis: ABC Widgets conducts a cost behavior analysis and determines that its variable costs represent 75% of its total production costs. This insight helps them understand how changes in production levels will affect their overall expenses.

Consultation with Accounting Team: The accounting team confirms that sales commissions, which amount to $20,000, are also variable costs, as they depend on the volume of sales.

Utilizing Accounting Software: ABC Widgets uses accounting software to track these variable costs in real time, allowing for better financial management and decision-making.

Common Questions About Variable Costs

How Can I Differentiate Between Variable and Fixed Costs?

To tell the difference between variable and fixed costs, think about how each one changes when the amount of output does. Variable costs go up or down depending on how much is made, but set costs stay the same no matter how much is made.

Can Variable Costs Change Over Time?

Yes, variable costs can change over time because of things like changes in the prices of raw materials, the wages of workers, or the speed of production. For correct financial management, you need to look over your variable costs on a regular basis.

Why is It Important to Track Variable Costs?

Tracking variable costs is crucial for several reasons:

• Profitability Analysis: Knowing about fluctuating costs helps you figure out your profit margins and set prices effectively.

• Budgeting: Accurate tracking helps you make better budgets and predictions, which lets you use your resources more wisely.

• Cost Control: Keeping an eye on fluctuating costs helps you find places to cut costs and make operations more efficient.

Read More: Fixed vs. Variable Overhead: Key Difference for Medspa Owner

Conclusion

Finding variable prices in financial statements is important for managing money and making smart decisions. Businesses can better control costs, set competitive prices, and do accurate profitability analyses if they know how these costs act.

You might want to work with a professional bookkeeping service like Irvine Bookkeeping if you find it hard to keep track of your changeable costs and your books. Our team's main job is to help small and medium-sized businesses improve their financial processes. This makes sure that everything is done correctly and saves you time.