Variable costs, also known as marginal costs, are those costs that rely heavily on the fluctuations in production and output. They do not remain constant and instead, the amount spent on them will constantly adjust with the change of production output. Generally, businesses that have a complex manufacturing process will have more variable costs compared to businesses with simpler processes.
Variable costs can be further divided into direct and indirect, or semi-variable costs. Direct variable costs are those that are directly related to the production of goods or services, such as raw materials, labour costs, and utilities. Indirect costs, also known as semi-variable costs, tend to have elements of both fixed and variable costs in them. Examples for this type of cost include administrative staff wages and insurance.
The cost of materials, fuel, labour, and transportation, are all typically considered standard variable costs. However, additional costs, such as advertising, packaging, packaging materials, and other overhead expenses, can be included in this definition.
In terms of general guidelines and best practices, businesses should try to accurately determine their variable costs before taking any action. It is important for businesses to know exactly how much their variable costs amount to in order to directly quantify how their production process will be affected by any changes. This is particularly important when it comes to controlling the production costs and managing business expenses.
As a first step, businesses should identify all the costs associated with producing their goods or services, including the cost of materials, labour, and other overhead expenses. Secondly, they should determine which of those costs are variable - or marginal - and which ones are fixed. Finally, they should use this data to monitor and measure the impact of changes in the production or output.
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In terms of practical advice, there are several best practices to consider. First, it is important to have a good understanding of the business’s costs and to predict accurately how those costs will vary with changes in production output. It is also important to determine which costs are necessary and manageable, and which are optional and subject to operational control.
Secondly, businesses should use productivity and cost measurement systems to accurately track costs, including both fixed and variable costs. These systems should be regularly updated to accurately track changes in production output and related costs. Finally, businesses should take the time to analyse their cost structure and consider whether making adjustments to their operations will result in improved financial results.
It is also key for businesses to diligently monitor their operating expenses and ensure that these are within their budget. They should locate any potential inefficiencies and ineffectiveness in their production processes and identify ways to reduce costs and optimise operations. Taking the time to analyse costs and measure performance can help businesses make informed decisions to reduce unnecessary production costs and enhance profitability.
Businesses should also pay close attention to their fixed costs. Fixed costs are typically more difficult to alter compared to variable costs and are necessary to maintain operations. Paying attention to these costs can help businesses remain competitive and keep costs under control.
It is important to note that businesses seeking to reduce variable costs should also consider their broader impacts, such as on customer service and product quality. Reducing variable costs without considering the impacts of those changes on customer service and product quality can negatively affect the business’s reputation.