Budget for Variable Expenses
The variable production costs are the production costs that can be varied to control the level of activity in the business. In other words, variable production costs can be easily changed. For example, the variable production cost for a furniture store is its prices for items sold, and for a restaurant, it is its food purchases. Fixed production costs are those which cannot be easily changed. For example, a factory’s rent or office space rates would have fixed rates set annually, and they cannot change this amount despite how much they produce during that period.
They can be translated into fixed costs by multiplying the variable fee with a coefficient. The varying expense times the coefficient is equal to the specified payment.
How to Budget for Variable Expenses
They are difficult to budget for because they can change often, and you should estimate these expenses using percentages. For example, suppose your products are sold at a retail average of $4 each for every $4 you make on a product. In that case, you need to have $0.75 allocated for these expenses associated with selling the product. Another variable would be payroll because this can change based on how many hours your employees work in a week or how many shifts they work in a day.
How to Use Variable Expenses
The trick for using these expenses is to determine the impact the expense will have on the total cost. If payroll jumps 5%, this could cause problems with cash flow because if you budgeted $300,000 in total costs and your payroll budget is $25,000, then it may not be possible to pay all of your bills if your sales drop by 5%. They are difficult to plan for, but they can be controlled.
Examples of these Expenses
They can include anything that can affect production, such as the number of employees, rent, or utilities.
They largely depend on your sales performance and the volume of products you produce. The more expenses you have, the more control you have over your budgeting and the higher your total costs will be. These expenses are more accessible to plan for than fixed expenses. They are much easier to see than fixed expenses, which are rare in planning because they only happen once a year or once every two years.
Issues related to fixed and variable expenses
From an accounting perspective, fixed expenses tend to be easy to handle. They are purely for cash flow and are easily tracked throughout the year. The main downside is that fixed payments often don’t happen frequently enough to allow for planning. For example, say you bought a new car that cost $20,000 with $3,000 in sales tax; the vehicle was purchased because it was needed to support sales growth. The tax charges were necessary because they were based on total income in the underlying jurisdiction.
These expenses, from an accounting perspective, are less straightforward. For example, if you rent a new office space every year as your business grows, you will be changing the fixed expense of your office space.
Fixed expenses can be easy to plan for, but they rarely happen, and if they do, you have to account for them as an increase or decrease, depending on if they are a fixed increase or a fixed decrease. They are more difficult to plan for because they happen frequently but aren’t always controllable.