What is a variable cost?

Variable cost (definition)

Variable costs are expenses that go up and down in line with business activity. The busier you are, the higher they go. They’re the opposite of fixed costs.

Many variable costs, such as inventory and freight, go up in line with the number of sales a business is making. But not all variable costs sync up in this way. Investments in marketing, trade shows, and sales travel might be intended to drive up sales, but they won’t always match up perfectly.

Examples of variable costs

  • Inventory and raw materials that go into the products and services you offer
  • Packaging and shipping of those goods
  • Transaction fees for accepting payments via card, digital wallet, and direct debit
  • Contractors that you hire during busy times
  • Marketing, which will go up and down depending on when you run campaigns
  • Sales travel, which will increase when reps go on the road
  • Commissions and referral bonuses paid on sales

Why variable costs matter

Variable costs change from week to week and month to month, depending on what the business is doing. They are complex and harder to budget than fixed costs. Understanding variable costs will help a business set accurate budgets and better predict their cash flow needs.

How variable costs differ from fixed costs

A cost is either variable or fixed. It can’t be both.

Fixed costs are expenses that stay the same no matter how active a business is. They are linked to rents, utilities, insurance, and permanent wages and salaries.

What are stepped costs?

Some variable costs go up in direct proportion with business activity. For example, inventory costs often go up in perfect alignment with sales. In other cases the relationship isn’t so linear.

A busy company might hire a new employee who can make another 200 products. The wage costs jump significantly, but it opens the door to another 200 sales. These sorts of variable costs are referred to as ‘stepped costs.’

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Disclaimer: This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.