In business, there is a total of three types of costs named variable cost, fixed cost, and semi-variable cost classified on the basis of variability. A fixed cost does not change with production. A variable cost is affected by the amount of production and the third, semi-variable cost consists of the characteristics of both variables as well as fixed cost.
People usually get confused in differentiating between both types of costs. In this article, you will learn about both variable and fixed cost with the help of a variety of examples and also learn about the key differences between both of them to establish a better understanding.
What is Variable cost?
A variable cost is a cost that changes with the change in the amount of production. This type of cost is directly affected by the variations in the activity level of the company. Variable cost directly depends on the volume of the production. Variable cost increases in accordance with the volume of the production and variable cost are zero when there is no production in the company.
Variable cost is usually different in different companies. The variable cost of a mobile manufacturer cannot be compared with the variable cost of a car manufacturer because the output of the products cannot be compared. However, the variable cost of a similar product manufacturer can be compared. The variable cost of production can be calculated by multiplying the number of units with the variable cost per unit.
Let us understand the concept of variable cost with the help of an example. For example, a company XYZ produces pens at the cost of $1 per pen. If the units of pens produced by the company are 1000 then the variable cost for the production of 1000 pens will be $1000 and in case the company does not produce any pen then its variable cost will automatically be zero. If the production volume of the company increases to 2000 pens then the variable cost will also become $2000.
This is the simplest example to make the concept clear and it is calculated without considering labor and raw material cost. Various types of cost that affect a variable cost are commissions, utility costs, labor costs, and the cost of raw material used in the production.
What is Fixed Cost?
A fixed cost is another type of cost which is independent of the business. This cost remains constant with the change in the amount of production. Fixed costs are always going there even if there are no goods are being produced. Therefore, fixed costs cannot be avoided. Let’s understand the concept of fixed costs with the help the same example that we have used to understand the variable cost.
For example, if a company XYZ incurs a fixed cost of $5000 per month for the machinery used to produce pens. If in case the company is not producing any pen for a month then the total incurred by the company will be at least $5000. And if in the next month, it produces 500 pens, even then the fixed cost is going to be the same. In that month the total expense of the company to produce pens will be $5500 ($5000+$500*1).
If the fixed cost of a company is high then it is required that it should produce and sell maximum goods, because fixed cost is always going to be there and it will never change. The examples of fixed cost are insurance, utilities, lease and rent payments, interest payments, and salaries. The impact of a company’s fixed cost varies based on the number of products it produces.
The impact of fixed cost reduces with the increase in production. The earning from a great number of products can be spread on the same value of fixed cost. Therefore, economies of scale can be achieved. In the end, we can say that fixed cost cannot be avoided or reduced but its burden can be overcome by producing a huge number of goods and earning a profit.
Difference between Variable cost and fixed cost.
|Variable Cost||Fixed Cost|
|Variable cost changes every time there is a change in the number of production units.||Fixed cost remains the same even when there is a change in the quantity of the production units.|
|Variable cost is volume-based that means it changes it changes with the change in quantity.||Fixed cost is time-based that means it stays constant for a specific time period.|
|Variable costs are indefinite. Variable cost is zero when there is no production.||Fixed cost is definite. There is always a fixed cost even when there is no production.|
|Variable cost remains the same per unit.||Fixed cost change per unit.|
|Variable cost is comprised while evaluating inventory.||Fixed cost is not comprised at the time of valuation of inventory.|
|Examples of variable cost are freight, material consumed, wages, packing expenses etc.||Examples of fixed cost are the tax, rent, depreciation, salary, duties, fees, and insurance etc.|
In conclusion, it is clear that both costs are quite different from one another and there are no similarities in both costs. It is important for you to learn about both types of costs so that you can manage them efficiently.