The term variable cost is used to describe those expenses which vary and change according to the level of business activity. Sometimes referred to as incremental, marginal or direct costs, they are defined as the amount by which total expenses increase following the production of one more unit.
The usefulness of variable costs to a small business start-up can be seen throughout the different areas of the budget setting and pricing decisions which it has to make.
Calculating the break-even point requires knowledge of the marginal and incremental costs of the products and services which the business sells in order to determine how much needs to be sold to achieve profitability.
Typically businesses will have a product or service cost card to identify the variable and other costs associated with the provision of that item. An example is shown below:
Cost card for the production of item X
Materials - 2 kilograms at £4 per kilogram
Labour costs - 1 hour at £8 per hour
Packaging - 1 foot at £3 per foot
Variable costs 2 x 4 + 1 x 8 + 1 x 3 = £19 per unit.
The above is therefore stating that the production of one of item X has a variable cost of £19 and therefore should be sold at a value at least equal or greater than this amount.
