Variable cost

Variable costs are expenses that change in direct proportion to the activity of a business.

For example, a manufacturing firm pays for raw materials. When activity is decreased, fewer raw material is used, and so the spending for raw materials naturally goes down. When activity is increased, more raw material is used and spending therefore rises. Note that the changes in expenses happen with little or no need for managerial intervention.

There are many expense categories in business that consist of both fixed and variable components, like electricity. A company will pay for line rental and maintenance fees each period regardless of how much power gets used. And some electrical equipment (air conditioning or lighting) may be kept running even in periods of low activity. These expenses can be regarded as fixed. But beyond this, the company will use electricity to run plant and machinery as required. The busier the company, the more the plant will be run, and so the more electricity gets used. This extra spending can therefore be regarded as variable.