For any modern company, increasing profitability is a constant concern. Fixed costs tend to be immovable, or extremely challenging to have any real effect on.
Therefore, variable costs represent a much more malleable expenditure that can be acted upon. Most organizations today, focus on reducing their variable costs.
For simplification, we will consider a bike shop:
The bike shop sells each bike for an average of $100.00.
Its variable cost for materials per bike is $21.50.
The fixed cost for rent and all utilities is $1500.
Using these metrics, we can analyze its profitability when compared to the total variable cost and the total fixed cost.
Let us assume each row is representative of a single month of business activity. The total sales and actual profit taken, are displayed below:
Total Variable Cost
Total Fixed Cost
A business will have a certain margin of profitability that it must maintain to stay in operation.
Note the loss the business incurred when sales were too low. 10 bikes were simply not enough to financially sustain the existing operations. In effect, this caused a $700 financial loss in a single month.
While the loss for the previous month was unfortunate, the bike shop poured its efforts into obtaining new customers by word of mouth. As a result, the next month proved profitable, and customers actively promoted their goods.
The table above represents an excellent variable cost example. Used in tandem with fixed cost, total cost, sales, and profit, we can quickly come to terms with an operation’s level of financial success.
A company such as the one depicted above, would likely be searching for ways to decrease its variable costs. This would require cutting expenditure on raw materials, advertising, or direct labor.
However, it should also be noted that any effort at eliminating cost must also not have a negative impact on the quality of the service or product being offered. If quality were to suffer, then it is also likely that overall sales would diminish as a direct result.