The Formula:
Unlike fixed costs that are rigid and don’t directly contribute to production, variable costs are flexible and vary according to the total output produced.
For example, when you buy a new car, you are incurring a fixed cost because although the vehicle is capable of driving, it can’t do so unless it has a consistent inflow of fuel now and then. The recurring expense of the fuel is what keeps the car running. The fuel is a variable cost.
In a business sense, fixed costs would be your machinery, factory, land, etc. Sure, those things are necessary to produce output, but simply setting those up isn’t going to produce output. To do that, you need raw material, labor, small equipment, etc.
Variable costs are directly proportional to your production i.e. they increase as production increases and decrease as production decreases. A rise in variable costs is often seen as an indicator of higher sales.
