That’s why, to find your operating expense ratio, you need to divide your total operating expenses by your total revenue. However, variable expenses affect the business more daily if they’re directly related to your sales volume. Along the manufacturing process, there are specific items that are usually variable costs. For the examples of these variable costs below, consider the manufacturing and distribution processes for a major athletic apparel producer.

Operating expenses appear on a company’s income statement and are recorded as part of the cost of goods sold (COGS). Knowing the COGS helps managers and accountants estimate the company’s bottom line—if the COGS increases, they know the net income will decrease. If a pizzeria needs to make pizza, then they need workers (wages), ovens (equipment), and plenty of dough, sauce, and toppings (materials). The cost of these things is the operating expenses that help continue the pizzeria’s production. So, if a small business called K & S Liquors has $20,000 in monthly sales, $6,000 in operating expenses, and a taxable NII of $3,000, then the overhead cost ratio is 15.4%. Variable cost and average variable cost may not always be equal due to price increase or pricing discounts.

Variable Cost vs. Average Variable Cost

These costs can be recorded on a company’s income statement as separate line items, but they will eventually be subtracted from total revenue or sales for the period in question. The marginal cost will take into account the total cost of production, including both fixed and variable costs. Since fixed costs are static, however, the weight of fixed costs will decline as production scales up.

For example, if a clothing store stopped selling clothes, its operating expenses would shrink because no material is needed. But just because the business owners stopped selling their products doesn’t mean they don’t have overhead costs, like rent, to pay out. Because variable costs scale alongside, every unit of output will theoretically have the same amount of variable costs. Therefore, total variable costs can be calculated by multiplying the total quantity of output by the unit variable cost. The concept of relevant range primarily relates to fixed costs, though variable costs may experience a relevant range of their own.

What Is the Formula for Total Variable Cost?

A variable cost is a corporate expense that changes in proportion to how much a company produces or sells. Variable costs increase or decrease depending on a company’s production or sales volume—they rise as production increases and fall as production decreases. In addition, compensation and benefits for production personnel and direct labor may be classified under operating expenses for accounting purposes. An operating expense is any type of expense that a company incurs during its normal day-to-day operations. Whether it’s a large corporation or a small, family-run enterprise, managers often look for ways to reduce their operating expenses (OPEXs).

This may hold true for tangible products going into a good as well as labor costs (i.e. it may cost overtime rates if a certain amount of hours are worked). Consider wholesale bulk pricing that prices goods by tiers based on quantity ordered. Fixed costs are expenses that remain the same regardless of production output. Whether a firm makes sales or not, it must pay its fixed costs, as these costs are independent of output. Therefore, a company can use average variable costing to analyze the most efficient point of manufacturing by calculating when to shut down production in the short-term.

Variable Cost: What It Is and How to Calculate It

The table below shows how the variable costs change as the number of cakes baked vary. Variable and fixed costs play into the degree of operating leverage a company has. In short, fixed costs are more risky, generate variable operating expenses a greater degree of leverage, and leaves the company with greater upside potential. On the other hand, variable costs are safer, generate less leverage, and leave the company with smaller upside potential.

• Luckily, there are a few things you, as a business owner, can do to cut your costs.
• These are costs composed of a mixture of both fixed and variable components.
• One of those cost profiles is a variable cost that only increases if the quantity of output also increases.
• Some companies also include the costs of goods sold (COGS) as an operating expense.