Mastering variable expenses is key to accurate budgeting and strategic cost management. But why is this understanding so vital?
In short, having a firm grip on variable expenses directly influences your financial outcomes and overall organizational health.
Differentiating Between Variable, Fixed, and Semi-Variable Costs
Every business has a cost structure made up of fixed, variable, and semi-variable expenses.
Knowing how these different expense types contribute to your overall cost base allows you to identify cost-saving opportunities and assess important metrics like profit margins and break-even points.
Fixed costs are predictable and stay the same from one budget period to the next, like property taxes, internet service, or rent.
Variable costs, on the other hand, fluctuate with activity levels, making them harder to predict without the right tools. These include expenses like labor, materials, and transaction fees.
Variable expenses often grow with sales volume—the more you sell, the higher these costs. However, higher variable costs can reduce your profit per unit, so managing them wisely is key.
Discretionary spending, a subset of variable costs, isn't tied to sales but varies based on management decisions, such as marketing or professional services.
Semi-variable costs, like phone bills, combine both fixed and variable elements, with part of the expense remaining constant and another part changing based on usage.
9 Common Variable Expenses You Should Know
Now that you understand where variable expenses fit into your business structure, let's dive into the most common examples that could impact your financial decisions.
1. Raw Materials
Raw or direct materials are basically the things you use to put your products together—like the ingredients in your recipe. Because they’re directly linked to what you’re selling, they really drive up costs in product-based businesses.
So, how can you cut those material costs?
One obvious way is to chat with your supplier. If you’re willing to sign a longer contract, you might snag lower prices per unit. Buying in bulk can also help you score a discount, just make sure it aligns with your sales forecasts to avoid wasting money on excess inventory.
Don’t forget to explore different suppliers, too! Ideally, you want to spark a little price bidding war to drive those rates down and get the best deal possible.
Lastly, think about whether you could redesign your product. Could you swap in some cheaper materials without losing quality? If that’s on the table, do some test runs before making any big changes.
Ways to reduce raw material costs:
Negotiate longer-term contracts with suppliers for better rates.
Purchase in bulk based on your sales forecasts to avoid excess carrying costs.
Explore alternative suppliers or materials to reduce costs without sacrificing quality.
2. Labor Costs
Direct labor is basically the cost of the workers involved in making your products.
If you want to cut down these costs, start by getting a grip on your customer volume trends and tweaking your work schedules. You'd be surprised how many businesses have too many or too few employees per shift! If you can find that sweet spot, you'll save on those extra payments for back-to-back shifts.
Next up, consider investing in training. The aim here is to boost efficiency so you don’t have to rely on overtime too much. Use it strategically—like when there's a seasonal spike in demand—rather than just hiring more people for the long haul.
On the topic of staffing, remember that hiring new employees can be way more expensive than keeping your current ones. Aim to keep that turnover rate low! Make sure your team feels valued; a little individual praise goes a long way, and it helps to let them know there are chances for advancement.
Don't forget to run some surveys to pinpoint any satisfaction issues, and conduct exit interviews to figure out why people are leaving, whether it’s about workplace culture, pay, or something else entirely.
To optimize labor expenses:
Understand customer demand to avoid over- or understaffing.
Invest in employee training to boost efficiency and reduce the need for costly overtime.
Retain employees to avoid the high costs of hiring and onboarding new staff.
3. Production Supplies
It’s great to standardize your production supplies to make inventory management a breeze. Plus, using predictive maintenance can help you minimize the supplies needed to keep your equipment running smoothly.
Don't forget to pay attention to your material handling processes! Can you cut down on damage to your supplies?
Tips to cut costs:
Negotiate bulk discounts for supplies.
Standardize supplies and utilize predictive maintenance to prevent excessive use or wastage.
4. Commissions and Sales Incentives
Offering sales commissions can boost productivity but can also increase costs.
Control these expenses by:
Implementing commission caps to limit excessive payouts.
Introducing tiered commission structures that balance quality and quantity.
5. Payment Processing Fees
Did you know not all credit card processing fees are necessary? Credit cards and their processing fees are often a part of doing business, especially in e-commerce.
Yep, what you end up paying can vary based on factors like your industry, transaction volume, and whether the card is present. These fees stack on top of your interchange rate!
If you have a physical store, consider offering incentives for customers who pay with cash to help cut down on those fees. And when you do need to accept card payments, there are some tricks to keep costs down.
First off, try to settle payments as quickly as you can to avoid interest piling up. Also, steer clear of chargebacks and use address verification to help prevent fraud. Credit card companies appreciate these efforts and might even reward you with lower rates.
How to manage these costs:
Encourage customers to pay with cash at physical locations.
Settle transactions quickly to avoid interest accrual.
Reduce chargebacks and use fraud-prevention tools for lower rates.
6. Utilities
Utility bills, such as electricity or water, can vary based on consumption levels.
Lower your bills by:
Identify inefficiencies by having an energy audit.
Reducing peak demand usage and renegotiating rates based on consumption patterns.
7. Shipping Costs
Shipping is a crucial cost for e-commerce businesses.
Save on shipping by:
Reducing package sizes or using lightweight materials like poly mailers.
Choosing local carriers for shorter deliveries and using third-party insurance.
8. Marketing and Sales Costs
These expenses include everything from traditional advertising to digital campaigns and promotional materials.
To optimize your marketing budget:
Use data-driven tools to evaluate which campaigns offer the best return on investment.
Factor in the time lag between campaign spending and its results for accurate forecasting.
9. Professional Services
These costs relate to outsourcing expertise, such as legal, consulting, or IT services.
Manage professional service expenses by:
Defining the scope and deliverables of projects clearly.
Weighing the long-term benefits of outsourcing against building internal capabilities.
Forecasting and Managing Variable Costs
One of the key functions of financial planning and analysis (FP&A) is future forecasting. While fixed costs are easy to predict, variable costs require a bit more work.
A straightforward approach is to analyze historical data to spot patterns. For a more advanced method, regression analysis can help identify how specific costs fluctuate with factors like sales or production volume. Sensitivity analysis can further aid in predicting changes based on varying inputs.
Scenario Planning for Variable Expenses
Relying solely on historical data leaves you vulnerable to unexpected changes in market conditions or the economy. Scenario planning helps you prepare for both the best and worst cases.
Worst-Case Scenario
A supplier drastically raises prices. Are you ready with alternative suppliers, or can you switch to cheaper materials?
Best-Case Scenario
Costs drop due to a strong supplier relationship. How would you reinvest those savings?
Scenario analysis helps you prepare for a range of possibilities and respond effectively to real-world changes.
Utilizing Technology to Optimize Costs
Modern financial software plays a crucial role in managing both fixed and variable expenses. With FP&A tools, you can easily collect data, run analyses, and visualize the impact of different cost scenarios.
Managing Variable Costs for Business Success
Mastering variable expenses is vital for financial health. From materials and labor to marketing and professional services, understanding how these costs fluctuate allows you to make better decisions, increase profitability, and position your business for sustainable growth.