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Variable Costs

Definition – Variable costs are directly related to sales. As sales go up, so do variable costs and as sales go down, variable costs go down. Variable costs are costs of labour or materials that change with sales. One way for a company to save money is to reduce its variable costs. Sometimes, calculating variable costs is as simple as looking at your costs of goods sold on your income statement.

The effect of cost management is often not fully understood, consider the following example a company which currently makes a 10% profit.  If your variable costs account for 50% of their turnover and they reduce it to 40% then the profit margin doubles to 20%. Another way of looking at this is that it now takes half the number of sales to achieve break-even which is essential in a poor financial climate.

Reducing Variable Costs

There are many different strategies you could use to reduce your variable costs, these include:

  1. Increase your price, this is the easiest way but many business owners believe it will drive them out of business. Most customers won’t even notice and if they do the chances are that they won’t care.
  2. You could reduce the cost of your team by putting your salespeople on a commission only basis.
  3. You could outsource parts of your manufacturing process that aren’t associated with your core skills to more specialist companies which have the skills to do this quicker and cheaper.
  4. Renegotiate the cost of goods with your suppliers, or consider joining forces with other small businesses to form a buying group taking advantage of discounts obtained with the increased purchasing power.
  5. Invest as much as you can in automated equipment, you might be surprised how much extra profit this will generate.
  6. Sell more higher margin goods or services, this doesn’t necessarily mean only stocking expensive items, quite often a lower priced item will offer a greater margin.
  7. Charge for credit cards, postage or delivery, in today’s ‘user-pays’ society it is common to be paid for your out of pocket expenses.