Variable Costs

In any business, it is important to understand how these two factors affect the bottom line. Variability in costs is a major factor in the inventory analysis and can help project managers in making decisions regarding plant layout, equipment, facility layout, demand forecasts and allocation of resources. Inventory is the product or service obtained in exchange for cash. The inventory balance is the difference between actual inventories and estimated maximum inventory levels. It can be determined by calculating the direct cost per item and the indirect cost per unit. Variability in inventory can result from demand, the price of good sold, or production and distribution efficiencies.

Variable costs occur as the amount of the service or product that a firm produces varies. In simple terms, variable costs are the amount of profit or loss per unit produced by the company. They can also be viewed as normal costs.

On one hand, the fixed cost of goods sold remains the same and variable costs, if any, tend to increase as production rates rise. However, if the firm has a large number of customers at different locations, it is possible that a rise in the price of a product will reduce profits somewhat. A firm's ability to absorb these increases depends largely on the elasticity of its pricing with respect to demand and competition. If a firm's customers are able to shift to competitors offering lower prices, the firm must either raise prices or reduce the supply of some goods to stay within a fixed cost level. The latter results in reduced profits and a fall in profitability.

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