Variable expenses or variable costs are the opposite of fixed expenses. While fixed expenses are constant, variable expenses fluctuate. It has a significant impact on a business budget. The varying amounts make planning a budget much harder.
Budgeting for variables isn’t an exact science. But we are going to teach you some tricks you can use to contain the runaway expenses. Let’s get started.
Understanding Business Expenses
Variable expenses are the result of your day-to-day business operations. Discretionary spending brings in a bit of fun and enjoyment in the course of your operations.
You could still run your business without incurring discretionary expenses. But they fit in the category of “good to have.”
Then there are the fixed costs, which pretty much speak for themselves. In this section, we will give you some examples of each type of cost.
- Insurance payments
- Loan repayments
- Annual salaries
- Utility bills
- Automobile usage expenses such as fuel and maintenance
- Professional services (Hourly charges)
- Payroll (Hourly Employees)
- Office supplies
- Meals and entertainment
- Staff party
- Client’s gifts
The bulleted list provides examples of costs in an operational setting. Variable costs also extend to the cost of goods sold.
If you are in the manufacturing business, then you will encounter variable costs of production.
Variable Costs of Production
In production, the variable expenses change with fluctuations in certain production activities. Some of these activities include production volume and sales volume.
The materials used to create a product are considered to be variable costs. This is because they vary according to the amount of the product manufactured.
The proportion of variable cost in business means different things. A high proportion of variable costs means that the company can thrive at a low sales level.
A high proportion of fixed costs does a business no good. For a business to survive, it must maintain a high sales volume.
The following are the terms of the variable cost associated with production.
Direct materials: This is the cost of raw materials that go into making a product.
Production supplies: Items like machinery and fuel are utilized based on the units per product made.
Piece rate labor: The amount of money paid to workers based on each unit of product made. This labor cost is different from the direct labor cost, which is a fixed expense.
In a direct labor expense, a minimum number of workers must stay in a production area. This constant number makes it a fixed cost.
Billable wages: Some companies bill the hours of employees. The employees are only paid according to the number of billable hours they work. This is different from a salary that pays out a fixed amount regardless of the number of hours worked.
Commissions: Salespeople earn a commission based on the number of sales they make.
Credit card fees: This applies to businesses that accept credit card payments. The credit card fees are charged according to the percentage of sales in the variable cost.
Freight out: A business pays this shipping cost whenever it makes a sale and ships out a product.
Understanding the types of variable expenses in production and operations is essential. It defines the point that your company breaks even. To become profitable, you need to exceed this amount.
Your business breaks even when sales are equal to the cost of labor and production.
How to Budget for Variable Expenses
Because variable expenses are dynamic, it can be challenging to plan for, so here are five methods make it easier:
1. Calculate the Annual Averages
When you are calculating the annual average, it is wise to go beyond the last 12 months. Take out at least three years of variable expenses and review them.
That much data will help you spot the anomalies that may impact the average variable expense.
Out of your annual averages, use the highest average to be on the safe side unless you have permanently eliminated a variable expense.
2. Create a Buffer for Inflation
After you have determined the average of each set of variable expenses, add a buffer. Adding a cushioning amount by 3 or 5% should safely cover any price increases or internal anomalies that could cause an outlier expense.
However, the safest buffer amount is 10%. Your business will be safest at this amount if your budget allocation can handle it.
3. Track Your Expenditure
After you prepare the variable expenses budget, compare the monthly expenditure to the budgeted amount.
Note if you were over or under the budget in each category. There is accounting software that makes this comparison to save you the effort.
4. Create a Savings Account
For every month you spend less, move the extra amount into a variable savings account. This provides you with a reserve for the months your variable expenses surpass the budget.
5. Re-Asses Variable Expenses Regularly
Do fresh variable expense reassessment annually. Do not give in to the temptation to use last year’s expense projection or stick to one constant annual projection figure.
You may have saved a significant amount of money on variable expenses in one year. That is the worst year to base your future annual projections upon.
With fresh analyses, you will discover new opportunities to make new strategic changes that lower your expenses.
With careful planning, you can control variable expenses. Even the most volatile of items can find a place in your budget account. It is crucial to build a buffer savings account if you do not already have one. This account will save you on the rainy months when the expenses surpass the projection.
Invest in accounting software to help you with your budget and cash flow analyses. Making an effort to frequently evaluate your costs will present you with new areas for improvement.