As a business owner, you are probably familiar with the concept of overhead costs. These are expenses that are incurred in the course of doing business, but are not directly tied to the production of goods or services. Variable overhead costs are a specific subset of overhead costs that can vary depending on a number of different factors. In this article, we will look at the basics of variable overhead costs, key components of these costs, how they differ from fixed overhead costs, examples of variable overhead costs in business, and how to manage and reduce these costs.

Understanding the Basics of Variable Overhead Costs

In simple terms, variable overhead costs are expenses that change based on the level of output of a business. For example, if you run a manufacturing plant, the cost of electricity used by your machines would be considered a variable overhead cost. The more you produce, the more electricity you will need, and the higher your variable overhead costs will be. Other examples of variable overhead costs might include fuel for a delivery truck or wages for part-time employees who work only when you have more business than usual.

It is important for businesses to understand their variable overhead costs in order to properly budget and plan for future growth. By analyzing past production levels and corresponding variable overhead costs, businesses can make informed decisions about how to allocate resources and increase efficiency. Additionally, identifying and reducing unnecessary variable overhead costs can lead to significant cost savings and increased profitability.

Key Components of Variable Overhead

The key components of variable overhead costs include costs related to labor, raw materials, and supplies. Labor costs for variable overhead might include the wages and benefits paid to part-time employees or overtime for full-time employees. Raw materials might include the cost of purchasing additional inventory to keep up with increased production, while supplies might include things like extra packaging materials. Basically, any expense that is incurred directly as a result of increased production could be considered a component of variable overhead.

Another important component of variable overhead costs is energy consumption. As production increases, so does the use of electricity, gas, and other forms of energy. This can result in higher utility bills and increased maintenance costs for equipment. Additionally, variable overhead costs may also include expenses related to shipping and transportation. As production increases, more products need to be shipped to customers, which can result in higher shipping costs and the need for additional transportation resources.

It is important for businesses to carefully monitor their variable overhead costs in order to maintain profitability. By analyzing these costs and identifying areas where expenses can be reduced, businesses can improve their bottom line and remain competitive in their industry. This may involve implementing more efficient production processes, negotiating better pricing with suppliers, or finding ways to reduce energy consumption and transportation costs.

How Variable Overhead Differs from Fixed Overhead

Unlike variable overhead costs, fixed overhead costs do not vary with production levels. These are expenses that are more or less constant, regardless of how much business you are doing. Examples of fixed overhead costs might include rent, insurance, and salaries for administrative staff. These are all expenses that do not change significantly based on your level of output.

However, it is important to note that fixed overhead costs can still be affected by external factors such as inflation or changes in the market. For example, if the cost of rent in your area increases, your fixed overhead costs will also increase, even if your level of production remains the same.

On the other hand, variable overhead costs are directly tied to production levels. These costs increase or decrease as your level of output changes. Examples of variable overhead costs might include raw materials, utilities, and shipping expenses. These costs can be more difficult to predict and manage, as they are directly impacted by the amount of business you are doing.

Examples of Variable Overhead Costs in Business

We’ve already touched on a few examples of variable overhead costs in business, but here are a few more to consider:

• Travel and entertainment expenses for sales teams that only incur expenses when they are meeting with clients
• Temporary labor or overtime expenses for manufacturing facilities that need to ramp up production for a short period of time
• Wages and benefits for part-time workers who only work when you have more business than usual

Another example of variable overhead costs in business is the cost of raw materials. The cost of raw materials can fluctuate based on market demand, availability, and other factors. For example, if there is a shortage of a particular raw material, the cost of that material may increase, leading to higher variable overhead costs for businesses that rely on it. Additionally, the cost of shipping and handling can also be considered a variable overhead cost, as it can vary based on the distance and mode of transportation used to transport goods.

Importance of Tracking and Managing Variable Overhead Expenses

Managing variable overhead expenses is important because it is an opportunity to improve profitability. By managing and reducing these costs, businesses can increase their profitability and become more competitive. Tracking variable overhead expenses can help businesses understand how much they are spending on these expenses and identify opportunities to reduce them. Businesses should also compare their variable overhead expenses against industry benchmarks to identify areas where they might be able to improve.

Another reason why tracking and managing variable overhead expenses is important is that it can help businesses make informed decisions about pricing. By understanding the true cost of producing a product or providing a service, businesses can set prices that are competitive and profitable. This can also help businesses avoid underpricing their products or services, which can lead to financial losses.

In addition, managing variable overhead expenses can also help businesses become more sustainable. By reducing waste and using resources more efficiently, businesses can lower their environmental impact and save money on expenses such as energy and materials. This can also improve the reputation of the business and attract environmentally conscious customers.

How to Calculate Your Business’s Variable Overhead Rate

Businesses can calculate their variable overhead rate by dividing their variable overhead costs by the number of units produced. This will give you an average cost for each unit of production. By knowing this average cost, businesses can make more informed decisions about pricing and production levels.

It is important for businesses to regularly calculate their variable overhead rate, as it can fluctuate based on changes in production levels and costs. By keeping track of this rate, businesses can identify areas where they can reduce costs and improve efficiency. Additionally, understanding the variable overhead rate can help businesses make more accurate financial projections and budgeting decisions.

Strategies for Reducing Variable Overhead Costs

Here are a few strategies that businesses can use to reduce variable overhead costs:

• Improve processes and reduce waste to increase efficiency
• Cross-train employees to reduce the need for temporary labor or overtime
• Use technology to automate processes and reduce manual labor costs
• Invest in more energy-efficient equipment to reduce electricity costs

Another strategy for reducing variable overhead costs is to negotiate better prices with suppliers. By finding suppliers who offer better prices for raw materials or other necessary supplies, businesses can reduce their variable costs and increase their profit margins.

Additionally, businesses can consider outsourcing certain tasks or functions to third-party providers. This can help reduce variable overhead costs by eliminating the need for in-house staff and equipment. Outsourcing can also provide access to specialized expertise and technology that may not be available in-house.

Common Mistakes to Avoid When Managing Variable Overhead

When managing variable overhead expenses, businesses should be aware of a few common mistakes to avoid:

• Not keeping track of expenses as they occur
• Being too focused on reducing costs at the expense of quality
• Not regularly reviewing and analyzing expenses to identify opportunities for improvement

One additional mistake to avoid when managing variable overhead is failing to consider the impact of external factors on expenses. For example, changes in market conditions or supplier prices can significantly affect variable overhead costs. It is important to stay informed and adjust your management strategies accordingly.

Another mistake to avoid is not involving employees in the management process. Employees who are directly involved in the production process may have valuable insights and suggestions for reducing variable overhead costs. By involving them in the process, you can create a culture of cost-consciousness and continuous improvement.

Comparing Variable and Fixed Overhead: Which is More Important?

While both variable and fixed overhead costs are important, variable overhead costs can have a bigger impact on profitability. Because these costs can vary depending on production levels, they have the potential to increase or decrease profitability based on how efficiently a business operates.

However, fixed overhead costs are still a crucial aspect of a business’s financial health. These costs, such as rent and salaries, are necessary for the business to operate and cannot be easily reduced. It is important for businesses to carefully manage both variable and fixed overhead costs to ensure long-term profitability.

Additionally, businesses should consider the industry they operate in when comparing variable and fixed overhead costs. Some industries may have higher fixed overhead costs, such as manufacturing, while others may have higher variable overhead costs, such as service industries. Understanding the unique cost structure of an industry can help businesses make informed decisions about where to allocate resources.

The Impact of Economic Factors on Variable Overhead

Economic factors can impact variable overhead costs in a number of ways. For example, if fuel prices rise, businesses that rely on delivery trucks might see their variable overhead costs increase. Similarly, changes in exchange rates can impact the cost of imported raw materials, which can then impact variable overhead costs.

Another economic factor that can impact variable overhead costs is inflation. Inflation can cause the prices of raw materials and other inputs to increase, which can then lead to an increase in variable overhead costs. Additionally, changes in government policies, such as changes in tax rates or regulations, can also impact variable overhead costs for businesses.

The Role of Technology in Managing and Reducing Variable Overhead

Technology can play a big role in managing and reducing variable overhead costs. For example, automated processes can reduce the need for manual labor, which can reduce variable overhead costs. Similarly, data analytics can help businesses identify areas where processes could be more efficient, which can reduce variable overhead costs.

In addition to automation and data analytics, technology can also help businesses track and monitor variable overhead costs in real-time. This can provide valuable insights into how much is being spent on variable overhead costs and where adjustments can be made to reduce those costs. For instance, a business may discover that a particular process is consuming more resources than necessary, and by making adjustments to that process, they can reduce variable overhead costs.

Furthermore, technology can also help businesses forecast variable overhead costs more accurately. By using historical data and predictive analytics, businesses can estimate how much they are likely to spend on variable overhead costs in the future. This can help them plan and budget more effectively, and make adjustments to their operations to reduce variable overhead costs where necessary.

Case Studies: Successful Ways Businesses Have Managed Their Variable Overhead

Here are a few examples of how businesses have successfully managed their variable overhead costs:

• A manufacturing company implemented a program to cross-train employees, reducing the need for temporary labor and overtime, and was able to reduce their variable overhead costs by 10%.
• An ecommerce company invested in a more energy-efficient warehouse management system, reducing their electricity costs and variable overhead expenses by 20%.

Another example of successful variable overhead management is a retail company that implemented a just-in-time inventory system, reducing their storage and handling costs and improving their cash flow. By implementing this system, they were able to reduce their variable overhead costs by 15%.

Future Trends in Managing and Analyzing Variable Overhead

The use of data analytics and automation in managing and analyzing variable overhead costs is likely to become more prevalent in the future. Additionally, as businesses become more focused on sustainability, there may be an increased emphasis on reducing variable overhead costs related to energy and resource usage.

Overall, managing variable overhead costs is an important aspect of running a profitable business. By understanding the basics of variable overhead costs, identifying key components, and implementing strategies to manage and reduce expenses, businesses can become more competitive and improve their profitability.

In addition to data analytics and sustainability, another trend in managing variable overhead costs is the use of cloud-based software. This allows businesses to access real-time data and analysis from anywhere, making it easier to track and manage variable overhead costs. Furthermore, cloud-based software can automate certain processes, reducing the need for manual labor and potentially lowering costs.