How to calculate AVC

By Indeed Editorial TeamFebruary 22, 2021There are several costs associated with running a business, and knowing how to calculate these costs can ensure your company is as profitab

How to calculate AVC

By Indeed Editorial Team

February 22, 2021

There are several costs associated with running a business, and knowing how to calculate these costs can ensure your company is as profitable as possible. One common cost business owners may need to know how to calculate is the total variable cost. In this article, we explain what total variable cost is, why it's important to your business and how to find it. We also provide a real-life example of calculating the total variable cost of a company.

What is total variable cost?

A company's total variable cost is the expenses that change in relation to the total production during a given time period. These costs are directly connected to a business' volume of production and may increase or decrease depending on how much a company produces. Unlike fixed costs, which stay the same regardless of production, variable costs can vary greatly depending on a company's productivity.

Common examples of variable costs include packaging, sales commissions, raw materials needed for production, labor associated with the manufacturing process and other expenses that are directly related to production. When fewer products are created, variable costs will decrease. On the other hand, when the production of products increases, so too will the variable costs a company incurs.

It's important to note that in addition to fixed and variable costs, there is another type of cost referred to as "semi-variable costs." These costs are combined with both fixed and variable costs and are based on a certain amount of production. Once this production level has been exceeded, the costs will go from fixed to variable.

Related: Learn About Being a Production Worker

How to calculate total variable cost

You can calculate total variable cost by multiplying the cost to make one unit of your product by the number of products you've developed. This formula can be used to calculate the total variable cost for a particular period:

Total output quantity x variable cost of each output unit = total variable cost

Follow these steps when using this formula to determine your company's total variable cost:

  1. Identify all variable costs associated with the production of one unit of product. Common variable costs to consider include cost of labor, cost of materials and variable overhead costs.
  2. Add all variable costs required to produce one unit together to get the total variable cost for one unit of production.
  3. Multiply the variable costs for one unit of product by the total number of units produced. The sum of this calculation will give you the total variable cost.

When determining the variable costs of production, the following are the most common costs to consider:

  • Production equipment, such as software
  • Employee wages
  • Sales commissions
  • Packaging costs
  • Shipment costs
  • Transaction fees
  • Production materials

Related: 15 Warehouse Jobs That Pay Well

Why is the total variable cost important?

Understanding the total variable costs of your business is important for a number of reasons. First, knowing which of your costs are variable and which are fixed can play an important role when making decisions. For example, if your company is low on funds, knowing which costs will have to be paid regardless can help you better prepare when planning how to deal with variable costs. On the other hand, being aware of the variable costs enables you to cut down on these costs where needed by reducing production.

Additional reasons why understanding and using total variable cost is important include:

  • It enables companies to determine their break-even analysis.
  • It allows businesses to determine where they can reduce input costs related to production.
  • It provides a basis for determining the profit projections of a business.
  • It allows investors to assess how a company handles varying operating conditions.

Further, variable costs can be used to compare your business or a business you are considering investing in with other companies within the same industry. However, it's important to note that these kinds of comparisons are generally only effective when comparing companies in the same industry.

Related: Operations Management: Everything You Need to Know

Total variable cost vs. average variable cost

The total variable cost of a company's production is equivalent to the total of how much it costs to produce one single unit of product. This number can be determined by multiplying how much it costs to produce one unit by how many products are produced in total.

While similar, the average variable cost is a different calculation that informs you of how much on average it costs to produce a single unit of product. The average variable cost uses the total variable cost to determine the average of the total variable cost for a number of products. The average variable cost is used when calculating variable costs per product for products that have varying costs per unit. To determine the average variable cost, you will need to find out the variable cost of each unit being analyzed and then calculate the mean of those costs.

Example of how to calculate total variable cost

The following is an example of how a company can calculate its total variable cost of production:

ABC Company wants to determine the total variable cost required to produce 100 of its products. To calculate the total variable cost, the company first determines its variable cost per unit for each product produced. They get the following numbers:

  • Direct material costs per unit: $12
  • Direct labor costs per unit: $15
  • Overhead costs per unit: $10

The variable costs to produce one unit is $12 + $15 + $10 = $37. This means that to make one product, the company must spend $37.

To determine the total variable cost the company will spend to produce 100 units of product, the following formula is used:

Total output quantity x variable cost of each output unit = total variable cost.

For this example, this formula is as follows: 100 x 37 = 3,700. This means that the total variable cost required to produce 100 units is $3,700.

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