Your business’s cost structure is composed of fixed, variable, and semi-variable expenses.
Understanding how these three expense types contribute to your overall cost structure allows you to identify opportunities for cost control and calculate crucial metrics like profit margin and break-even point.
Fixed Expenses remain the same from budget to budget and may include property taxes, Internet service, and rent payments.
Variable Expenses, however, do not remain the same from budget to budget. This makes them tough to predict, especially without the right tools. Examples of variable expenses include labor costs, materials, and credit card processing fees.
Variable expenses are usually tied to sales—the more you sell, the greater your variable costs. The problem with this is the greater your variable costs, the lower your revenue per unit. So, while variable costs are unavoidable, your goal should be to keep them as low as (realistically) possible.
Discretionary spending is a subtype of variable expenses. These are not tied to sales but vary based on management decisions. Some examples include advertising and marketing, as well as professional services.
Semi-Variable Costs aren’t fixed or variable costs, but have features of both. Telephone bills are a great example—there’s a fixed, monthly rate, as well as a variable rate depending on how many calls were made.
9 Variable Expenses Examples You Should Know
Now that you have a better idea of where variable expenses come into play, let’s review some of the main types of variable expenses you should know to help you make more informed, impactful financial decisions.
1. Direct Materials
Direct materials are the components you use to assemble products. These materials are identifiable with the product (think fabric in a piece of clothing). That’s why they’re one of the main cost drivers in product-based businesses.
How to reduce direct material costs:
- Negotiate with your supplier to secure cheaper prices per unit or longer contracts.
- Buy in bulk but align purchases with your sales forecasts to minimize carrying costs.
- Look for alternative suppliers to create competitive pricing.
- Redesign products to use less expensive materials without sacrificing quality.
2. Direct Labor
Direct labor is the cost of labor that goes into manufacturing products.
How to reduce direct labor costs:
- Understand customer volume trends and optimize work schedules.
- Invest in training to increase efficiency and reduce overtime.
- Retain employees to minimize hiring costs by fostering a positive workplace culture.
- Conduct satisfaction surveys and exit interviews to identify and address turnover causes.
3. Production Supplies
Production supplies include oils, adhesives, and safety equipment, among other items.
How to manage production supply costs:
- Negotiate contracts for bulk discounts.
- Standardize supplies to streamline inventory management.
- Use predictive maintenance to minimize supply usage.
- Optimize material handling processes to reduce damage and spoilage.
4. Commissions and Sales Incentives
Commissions can reduce labor costs by driving productivity but require careful management.
How to control commission costs:
- Implement commission caps to limit individual payouts.
- Use tiered commission rates to balance quality and quantity.
5. Credit Card Processing Fees
Credit card processing fees vary based on factors like transaction volume and industry.
How to reduce these fees:
- Offer incentives for cash payments in physical locations.
- Settle payments quickly to avoid accruing interest.
- Use address verification to prevent fraud and negotiate lower rates with processors.
6. Utility Costs
Utility costs are essential expenses that can add up quickly.
How to reduce utility costs:
- Review your contract for any penalties tied to consumption reductions.
- Conduct energy audits to identify inefficiencies.
- Reduce peak demand by staggering employee hours or limiting equipment use during peak times.
- Upgrade equipment for greater efficiency, even if it requires an initial investment.
7. Shipping Costs
Shipping costs are critical for e-commerce businesses.
How to lower shipping expenses:
- Negotiate lower rates for higher volumes.
- Use smaller, lighter packaging to cut costs.
- Standardize packaging sizes to improve efficiency.
- Use local carriers for local shipments and consider third-party insurance.
8. Sales and Marketing Expenses
Sales and marketing expenses include advertising, digital marketing, and events.
How to optimize these expenses:
- Monitor ROI to focus spending on effective campaigns.
- Use analytics tools to track performance and customer acquisition costs.
- Plan for time lags between marketing spend and revenue impact.
9. Professional Services
Professional services refer to external expertise like consulting, legal, auditing, or IT.
How to manage professional service costs:
- Clearly define project scope and deliverables to avoid cost overruns.
- Assess whether to build internal capabilities or hire externally based on long-term goals.
Forecasting Variable Expenses
Forecasting variable expenses is a crucial financial planning activity. Fixed costs are predictable, but variable costs require deeper analysis.
How to forecast variable costs:
- Use historical data: Review past expenses to identify trends.
- Apply regression analysis: Analyze how specific expenses change with sales or other factors.
- Perform sensitivity analysis: Test different scenarios to predict future costs under varying conditions.
- Utilize scenario analysis: Prepare contingency plans for best- and worst-case scenarios.
Leverage Technology for Expense Management
Modern financial planning tools, like PivotXL, make managing variable expenses more efficient. With features like data aggregation, scenario modeling, and sensitivity analysis, you can make data-driven decisions to optimize costs and improve profitability.
Conclusion: Variable Expenses Can Make or Break Your Business
Understanding and effectively managing variable expenses is crucial for sustainable growth. By focusing on key areas like direct materials, labor, and shipping costs, and leveraging advanced tools, you can navigate financial decisions with greater confidence and precision.
Ready to take control of your variable expenses? Learn how PivotXL can streamline your financial planning and analysis. Request a free demo today.
