Variable Cost

  

Categories: Accounting

Some prices remain the same over long periods of time, no matter what production levels you achieve. This category is known as fixed costs. Other expenses change with your level of production, or frequently see their prices move around. These costs that move around a lot are known as variable costs.

At your factory, which produces fur-lined underwear, you pay your assembly-line workers $48,000 a year, or $4,000 a month. You pay that amount no matter how many pairs of underwear you crank out. On a regular day, a single worker might make 1,000 pairs of undies. But if the fur-lining machine goes down for repairs, and they make 250 pairs that day, you still owe them the same salary. The cost is fixed. It doesn't change.

Other examples of fixed costs include the rent for your factory and your company's insurance. You have to pay the same amount every month, no matter what.

However, other costs are variable. They change as production changes...like the fur that goes into the underwear. It costs $1 to buy enough fur for one pair of underwear. If you make 1,000 pairs in a day, that cost you $1,000. If you make 250 pairs in a day, it costs $250. The costs vary depending on the situation. Variable costs.

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Cost Accounting: What Are the Four Types...19 Views

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And finance Allah Shmoop What are the four types of

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costs Oh all right Well lots of things come in

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fours legal's the horsemen of the Apocalypse and Stooges you

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know don't forget ship Okay so in practical reality these

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concepts actually matter how so Well think about your personal

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budget The one you used to direct your day to

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day expenses There are four universally accepted types of costs

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for a regular person's budget rent Internet burritos and yes

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video games Now think about a company As with your

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budget well there are four types of costs that a

00:37

company has to consider the categories air well slightly different

00:40

though generally speaking of business has to keep in mind

00:42

these four kinds of expenses fixed variable semi variable and

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step The categories correspond to how much the cost changes

00:49

When the amount of output changes you increase the amount

00:52

of stuff you make Well how much did that cost

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change Not at all Well then it's a fixed cost

00:58

The cost changes proportionally with every increase in production Well

01:02

then that's a variable cost somewhere in between wealth And

01:06

that's semi variable or step Well you own a factory

01:09

that makes toothpicks for Gap tooth people made from exotic

01:13

hardwoods It's called the Dunaway Letterman Jack O Lantern company

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Tough to fit on a mug but well you like

01:18

it You make one hundred thousand box of toothpicks a

01:20

month and you want to ratchet that number up to

01:23

one hundred twenty thousand boxes a twenty percent bump Well

01:26

how will the increased production effect costs Well the actual

01:29

cost will respond differently It depends on what category they

01:32

fit into Will all of the costs go up twenty

01:35

percent with this increase in production Yeah probably not Meaning

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the company will scale You'll produce more and you'll have

01:42

higher profits So quick tour Here we go Fixed costs

01:45

don't change at all They stay the same no matter

01:47

how much you make that is fixed Like the toothpick

01:50

grinding floor the sawdust sucking system the factory building itself

01:55

fifty thousand units eighty thousand units a hundred thousand units

01:59

that fixed cost is all the same If you decided

02:02

to make eighteen million units Well then things would be

02:04

different But at this scale or this level it's all

02:07

fixed It's all the same The only big notable difference

02:09

is that the fixed costs and of the factory is

02:12

now amor ties over a larger number That is if

02:15

it cost twenty grand a month to rent that factory

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and all the equipment in it If you made twenty

02:19

thousand toothpick boxes a month while the fixed cost per

02:23

box would be a buck if you made two hundred

02:25

thousand creep pick boxes in a month we'll then the

02:27

fixed cost per box would be a dime right That's

02:30

fixed It doesn't change month after month after month as

02:33

it Rikers and you basically save money when you have

02:36

big volume output Because the cost per fixed foot is

02:39

a flat variable costs are directly linked to the amount

02:42

of output Factories making and variable you know varies well

02:46

The increase in cost here is pro pie fortune All

02:48

make one more to thicken the variable cost increase accordingly

02:52

Why Well because you have to buy more raw wood

02:54

supplies to put through the system you have to run

02:56

the saws longer You have more sawdust to clean more

02:59

packing material to by someone Someone more Output demands more

03:02

input So think high brand fiber food something like that

03:06

okay Next semi variable costs have elements of fixed and

03:09

elements of variable costs Usually they have a fixed component

03:12

and a variable component like the electricity to run the

03:15

machine that puts the little plastic flew fi things at

03:18

the end of the toothpicks Turning it on takes a

03:20

certain amount of baseline electricity That part is fixed but

03:23

then running the machine takes a little extra electricity for

03:26

each flukey thing that gets installed That part is variable

03:29

so the cost of running the machine gets thrown into

03:31

the semi variable group A little bit fixed and a

03:34

little bit variable Got it Alright last category step costs

03:38

these increase in levels or scale The increase isn't proportional

03:42

as with variable cost but instead takes place in steps

03:45

like step cost might stay the same One output rises

03:47

from one hundred thousand to one hundred twenty thousand boxes

03:50

but then the one hundred twenty thousand and first item

03:53

causes the step cost to bump up The cost jumps

03:56

up in chunks and it stays the same for a

03:58

while But then a certain point moves it to a

04:00

higher level like you need a scale box Packer or

04:03

you need some other thing that handles ten thousand maur

04:06

twenty thousand fifty thousand more boxes because that's a whole

04:09

different scale set of demands than if you were just

04:11

packing a few hundred boxes You could do those manually

04:14

You don't need the high tech robots then to do

04:16

it right So it stayed same for a while as

04:18

a staff and then it reaches another production point and

04:20

then costs kind of zoom up well breaking down a

04:22

little more detail fixed Think Brent your toothpick factory cost

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ten thousand month and rent It cost that much If

04:29

you meant no toothpicks it cost that much If you

04:31

make a thousand boxes of toothpicks and a cost that

04:33

much If you make one hundred thousand box of toothpicks

04:35

that rent is fixed it doesn't change To get the

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most out of a fixed costs You want to make

04:39

his many things as possible As many Turbo Whittle five

04:42

thousand machines is you could fit into the factory Maximizing

04:45

volume production allows you to get the most out of

04:47

those fixed costs of rent per dollars spent Okay you

04:50

spent ten thousand dollars rent to make one toothpick while

04:53

that becomes a really expensive to pick right You have

04:55

to find someone to pay at least ten thousand dollars

04:57

for it plus all the other costs related to making

04:59

that one little wood sliver but make ten thousand or

05:02

one hundred thousand boxes of toothpicks and your rent expense

05:05

Well then is only a ten cents a box right

05:07

Next type variable The type of expense increases proportionally without

05:11

put raw material expense is a good example Each toothpick

05:14

needs so much African black wood or South American cedar

05:17

Yeah say you need three dollars worth of African black

05:20

wood to make ten boxes of toothpicks Still making one

05:22

box would cost thirty cents Making ten boxes will cost

05:25

three bucks and making one hundred thousand will cost thirty

05:28

grand and making one hundred thousand one boxes will cost

05:31

thirty thousand and three dollars of the African Blackwood stuff

05:35

right Because the same cost and no matter what volume

05:37

you order the cost goes up in what's called a

05:39

linear progression A straight line on a graph Labor can

05:43

also work this way but it depends on how you

05:45

pay your workers Pay them on a per piece basis

05:47

And it's completely variable Bob Splinter gets paid a penny

05:52

for every toothpick he makes He makes a thousand toothpicks

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He gets a ten box He makes two thousand five

05:56

hundred twenty three toothpicks He gets twenty five dollars twenty

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three cents It's completely variable but Bob joins the Toothpick

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makers local one forty two Their contract calls for an

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hourly wage twenty five dollars an hour Plus Bob is

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guaranteed forty hours a week Well now his wages aren't

06:12

fixed at a grand A week there It doesn't matter

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how many toothpicks he makes in an hour Bob gets

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the same amount no matter what So if you can

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get more efficient with production if you can figure out

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how to make more per hour we'll then you Khun

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Stretch the labor cost Mohr Just as with the rent

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costs while you're proportional per unit cost will go down

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the more you make in the same amount of time

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on two semi variable elements of both fixed and variable

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cost Think about the pay for a sales person with

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a fixed salary of fifty grand a year to your

06:39

sales associate You also give them a bonus of two

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dollars per ten boxes sold So each additional ten box

06:45

units sold carries a two dollars variable cost to you

06:48

related to commission But the salary is a fixed cost

06:51

It gets relatively less expensive per unit with each additional

06:55

sail Right You're going to pay fifty grand no matter

06:57

what if the sales person sells ten boxes in a

06:59

year Well the sales cost for that unit is fifty

07:02

thousand two dollars The full salary plus the two dollar

07:05

commission yet really expensive Yeah You just pay the salesperson

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five thousand dollars in twenty cents for each box of

07:11

toothpicks they sold Yeah that was a bad deal If

07:13

they sell ten thousand boxes will Now the overall cost

07:16

is fifty two thousand for the year fifty grand in

07:18

salary and two grand for the total commission for those

07:20

thousand units Your paying Mohr on an absolute basis but

07:23

the per box amount is much better now You pay

07:26

just five twenty per box Okay so let's look at

07:29

the big winnings Compensation for one hundred thousand boxes sold

07:32

in a year Total cost goes up to seventy thousand

07:36

again Maurin Absolute basis Fifty thousand salary twenty thousand Commission

07:39

But now the per box costs just seventy cents Lastly

07:42

there's the step category Instead of a per unit commission

07:45

you offer your salespeople a bonus when they hit a

07:48

certain level If they sell a hundred thousand units they

07:50

get a twenty thousand dollar bonus So sales one through

07:53

ninety nine thousand nine hundred ninety nine while the sales

07:55

person earns fifty grand for the year on sale number

07:58

one hundred thousand They earned seventy thousand for the year

08:01

fifty grand in salary And you know the twenty grand

08:03

bonus that hundred thousand sail becomes very expensive for you

08:08

may be worth it to incentivize your sales force though

08:10

so you gotta think about that stuff But because of

08:12

the structure of strategy surrounding step costs are often different

08:15

than the other three categories Right Did you get that

08:17

big step function when they hit their next level of

08:19

bonus For each of the other categories it's better to

08:22

make output as high as possible Or in the case

08:24

of variable costs it's at least neutral Assume you sell

08:27

everything you make and that making tons of stuff doesn't

08:30

force prices down Well then given your ability to sell

08:33

everything and maintain pricing levels It's more profitable to make

08:36

a cz much as possible with fixed and semi variable

08:38

costs for each of those categories the per unit cost

08:41

goes down with each additional toothpick you make The per

08:43

unit cost of variable expenses states the same but it

08:45

doesn't cost any more at least on a relative basis

08:48

to make more So why not make more especially as

08:50

you're fixed and semi variable cost get relatively cheaper Is

08:54

output increases right Well step costs work differently as you've

08:56

seen there Khun B scenarios where it's more profitable to

08:59

not go to that next step and hopefully not have

09:01

to pay all those bonuses You Grinch In the case

09:04

of the sales bonus that hundred thousand unit comes with

09:06

a twenty thousand dollars sales price tag meaning that big

09:09

bump in commission to your sales force Well it might

09:12

be best just to make ninety nine thousand nine hundred

09:14

and nine boxes and call it a day But then

09:16

when the clock resets on the bonus well then you

09:18

start again at one sale Staff will not be happy

09:21

but well that one time you could save twenty grand

09:23

bonus and good luck with that That's not how the

09:25

real world works Is that bonus money worth a hostile

09:28

work environment create Yet Not for us to say You'll 00:09:30.462 --> [endTime] have Tio you know pick your own battles

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