How to Know Your Variable Costs to Increase Profits in Your Small Business

If you don’t know your variable costs you don’t have the information you need to maximize the profits in your small business. You don’t have the information you need to price your products and services. You can't operate your small business with the accuracy and precision to maximize your profits. Variable costs are a key com of your profit and loss statement.

What Are Variable Costs?

So what exactly are variable costs? These costs vary depending on your volume; they rise as production rises and fall as production falls. Variable costs differ from fixed costs such as rent which tend to remain the same regardless of production output. Fixed costs, along with variable costs, comprise total cost on your income statement.

Variable costs can include direct material costs, direct labor costs, and other required inputs necessary to complete a project. For example, a company may have variable costs associated with the packaging of one of its products. As the company sells more, the packaging costs increase in direct proportion to sales. Conversely, when fewer of these products are sold, packaging costs will decrease. The same goes with energy-intensive products. That is the nature of variable costs.

What You Don't Know Can Cost You

When you don’t know your variable costs you can’t be sure how to price your offerings, your profit margin, or whether to take on a new project to make a profit. This knowledge gap seriously hampers your business decision making and your problem solving.

If you underestimate your variable costs, you could lose money on every unit; this is the most serious situation. It is a total drain on cash and it's a real business killer. When you don't cover variable costs there is no contribution to overhead and fixed costs. The immutable rule is that all orders must cover variable costs, plus a contribution.

Calculate Your Variable Costs

Calculate your variable costs by product. Common variable costs are: labor, materials, packaging, some parts of energy, servicing, warranty, and delivery costs.

Variable costs can be managed somewhat with bulk orders and creative sourcing of both labor and materials. Any time you can cut costs while maintaining quality, the difference goes straight to your bottom line.

Do you know with precision your variable costs by offering?

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Author's Bio: 

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Donna Marie Thompson, PhD is a Small Business Profitability Expert and Founder of Expert Profit Solutions. She is a two-time best-selling author who has spent most of her career problem solving in international management consulting.

Donna Marie has helped businesses meet their profit targets under challenging circumstances. She was a Director at PricewaterhouseCooper's Consulting, and has worked at Booz Allen, as well as local consulting firms. This wide range of experience in businesses of all sizes uniquely qualifies Donna Marie to guide small businesses to discover their hidden profit potential.

Donna Marie earned a PhD from George Washington University, an MBA from Virginia Polytechnic Institute, a CPA in the state of Maryland, and is a Master Practitioner of the Energy Leadership Index.