Variable costs vs fixed costs: everything businesses need to know

What is an example of a variable cost?

A variable cost can go up or down depending on your production levels. For example if you need to hire more staff to fulfil an increase in orders, your variable cost for labour would increase.

Here are some examples of the most common types of variable cost:

• labour costs and commission

• raw materials and production supplies

• packaging and shipping costs

• credit card fees

• travel costs

Working these out and adding them together can give you an idea of the total variable cost to create and sell a specific product or service.

How to calculate variable cost

When you work out variable costs, you can look at the total variable cost and the average variable cost.

The total variable cost shows you how much it costs to sell one type of product, while the average variable cost shows the combined total cost across several products.

The formula for working out the total variable cost is:

The formula for working out the average variable cost is:

Example variable cost calculation

As an example, you run a small business that sells handmade furniture and want to work out your variable costs.

Firstly, you want to work out the total variable cost for a set of kitchen chairs you sell for £500. The chairs cost £300 to make, advertise, and package.

You have six sets of the chairs with a variable cost per unit of £300, adding up to a total variable cost of £1,800.

You also want to work out the average variable cost for the kitchen chairs and another one of your products, a set of living room lampshades.

You have four sets of the lampshades with a variable cost per unit of £187.50, adding up to a total variable cost of £750.

The total variable cost for the two products is £2,550 (£1,800 + £750). This sum divided by the total number of units (10), leaves you with an average variable cost for the two products of £255.

When should you work out variable costs?

Knowing your variable costs is helpful when it comes to setting your prices. Making sure your prices are significantly higher than your variable costs will allow your business to cover its fixed costs and ultimately make a profit.

For example, an online retailer sells handmade towels. They have a variable cost of £10 for each towel they sell and annual fixed costs of £15,000 (including insurance, rent, and fixed utilities).

If the retailer expects to sell 825 towels a year, they’ll need to contribute £18 per sale (£15,000 divided by 825) towards their fixed costs to avoid making a loss.

As a result, if they want to make a profit they’ll need to set their prices higher than £28 (£10 variable cost + £18 fixed cost contribution).

By understanding their variable costs and fixed costs, they can set their prices at the right level.

Many businesses use variable costs to work out their break even point – the amount of income they need to make to cover all their costs. Read our guide to working out your break even point for more information.