What are "variable costs"?

Variable costs represent expenses that fluctuate in direct proportion to the level of goods or services produced by a business. As production increases, variable costs increase because they are directly tied to the operational activity of the business. Common examples of variable costs include raw materials, direct labor (when paid by the hour), and sales commissions, all of which vary based on production levels. This relationship makes it essential for businesses to monitor variable costs closely, especially when planning budgets and forecasting profits, as they directly impact overall profitability depending on the volume of sales or production.

In contrast, fixed costs remain constant regardless of production levels, making them distinct from variable costs. Long-term investment costs also do not fluctuate with the levels of production but are related to the acquisition of fixed assets for use over an extended period. Therefore, recognizing that variable costs are key indicators of financial performance at different production levels helps in effective budget planning and financial forecasting.