Companies in today’s market have to deal with a lot of rising costs that are a result of a number of factors. Compared to ten or fifteen years ago, enterprises now have to deal with higher wages and employee benefits. Also, they face expensive materials, and even pay more for commercial spaces. It is why entrepreneurs are always looking for ways to cut back on expenses. Therefore, variable costs are some of the areas to consider. Lower variable costs can increase the profit margins of an enterprise, which is the primary objective of any business.
Some entrepreneurs assume that the only way to boost revenues is to grow sales but doing that also means spending more on production, subsequently inflating variable and fixed costs. Controlling the expenditures of your company allows you to avoid paying more to provide goods for consumers. Meanwhile, you maintain the quality and volume of merchandise. Because variable costs don’t have to occur in a linear fashion, it is possible to make sacrifices in some areas. So you will decrease the percentage of operating capital you have to allocate to these expenses.
What Are Variable Costs?
An enterprise has costs divided in two; fixed and variable. Variable costs fluctuate with the production of a company. So when production is low, the variable expenses go down and vice versa. Direct labor and materials, are examples of variables expenditures because when you have to increase sales. This means buying more materials and hiring more people to achieve the new targets.
Variable expenses may also shift according to seasonal promotional efforts and supplier prices. For example, let’s take a supplier which offers a discount for certain raw materials. Then, expenditures for that month or year will decrease. Variable costs are also present in service-based industries because of the labor aspect. For instance, in a cleaning business, the more offices your staff cleans, the more you have to pay in terms of wages.
Who Needs Variable Costs?
The shifting expenses are present in almost all businesses. Any enterprise that pays wages has an element of variable costs. This appears especially when employees earn commissions. Production companies have more variable costs than others because of the different elements involved in providing finished goods. Such an entity has to factor in labor and raw materials. Also, they pay for packaging, distribution, and shipping costs.
Entrepreneurs must factor in the variable and fixed cost framework to understand the economies of scale. For a beginner, start by analyzing any expenditure that is directly influenced by business activity. Then, classify it as a variable expense. Some costs such as worker wages can have both a fixed and variable aspect. This is when there is the constant salary agreed upon (fixed) and a commission that is based on the number of sales made (variable).
How Much Is Usually Spent on Variable Costs?
As with any other expenses, variable costs vary from one business to the next. A multitude of elements determines how much an enterprise has to allocate to its variable expenditure. The main of them is the size of an organization. The bigger it is, the higher the variable costs. The type of industry also matters. For example, the raw materials required by an automaker are more expensive than those needed by a clothing manufacturer. You also have to consider where an enterprise purchases its material and sources its labor.
A business that has to spend $30,000 on raw material, $20,000 on packaging and $100,000 on wages, incurs a total variable cost of $150,000. The figures are for the production volume for a particular period, say one year. If you want the variable cost of each unit, you need to divide the total VC with the number of units. If the $150,000 is for 500,000 units, it means that a single one costs $0.3 to produce. In such an instance, an enterprise will incur $0.3 for every additional unit. A company should ensure that there is a balance between variable and fixed costs to manage risks and profitability.
6 Strategies to Reduce Your Company’s Variable Costs
1. Check for Volume Discounts
They are great ways to get similar quality of raw materials without inflating variable costs. Sometimes, suppliers offer deals to companies that buy products in particular volumes. You can capitalize on this. The more your volume increases, the better the discounts. Consequently, the more the savings
2. Ensure Manufacturing Efficiency
Manufacturing efficiency can save your company a considerable amount of variable costs. Inefficiencies can lead to high labor costs. That can hike your variable expenditures. By training workers in efficiency strategies, you can cut labor time significantly. Ensure that the work environment provides appropriate conditions. If the tools are suited for the job, then systems don’t cause disruptions.
3. Update Materials for Work
The type of material used for manufacturing may also be the reason your enterprise is dealing with high variable expenditures. It may be possible to manufacture the same quality product with a different type of material that doesn’t cost as much. Purchasing materials in different sizes may allow you to reduce wastage. So, by extension, this influences variable costs.
4. Consider the Equipment
The equipment used in the production process may also be the reason your variable costs are eating up a huge part of your operating expenses. There are now modern technological advances. Companies can find highly efficient machines that improve the manufacturing process in various ways.
5. Rethink Your Product
Reworking the product is another strategy that can help keep the variable expenses low. Evaluate the engineering of your product. Is there another way to approach it? You may find a design that uses less material without compromising the functionality, safety or standard of a product. By eliminating certain features or restructuring them differently, you can reduce the assembly time of a product. You will, therefore, decrease the labor needed.
6. Outsource Some Work
Outsourcing some of the production tasks can lead to lower variable costs. For instance, you may choose to avoid paying for warehouse space, packaging equipment, and the human power. Then, you can have another company do all that if it will cost less.
Summing Up Expenses
Your enterprise could incur high variable costs than the industry standards. Then it’s time to implement effective cost cutting measures. Slashing your variable expenditures doesn’t necessarily mean reducing production. It doesn’t even mean paying for second-grade materials. You only need to find viable alternatives to produce the same goods without the high expenses. Then, you gain a competitive advantage that is hard to beat.
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