Variable Cost Ratio

Variable Cost Ratio
See also
Marginal revenue Differential costing Net income margin Profit Operational gearing Contribution margin ratio Absorbed costs Operating expense ratio Direct expense

Variable cost ratio is "the proportion of each sales dollar that must be used to cover variable costs. The variable cost ratio can be computed using either total data or unit data" (M. M. Mowen, D. R. Hansen, D. L. Heitger 2012, s. 114).

Formulas

$Variable\ cost\ ratio={\frac {Total\ variable\ cost}{Sales}}$

or

$Variable\ cost\ ratio={\frac {Unit\ variable\ cost}{Sales}}$

(M. M. Mowen, D. R. Hansen, L. Guan 2009, s. 613).

Variable costs

Variable costs (VC) are often referred to as direct costs or main costs. Examples of variable costs could be raw materials, energy, and direct labor wages (B. Harrison, C. Smith, B. Davies 1992, s. 74) . They change with the level of production: the more products a company produces, the greater the total variable production costs. This relationship can also be expressed by a simple equation (H. B. Mayo 2012, s. 375): $VC=Per-unit\ variable\ cost\cdot Quantity=VQ$ The equation says that variable costs are the variable cost per unit multiplied by the quantity of production, with V being the variable cost of production per unit. As production levels increase, variable costs increase proportionally to production growth. At zero production, there are zero variable costs. For example, each additional production unit then adds $ 1 to the company's variable costs. Thus, with 200 production units, these costs amount to US$200, and with 1000 production units these costs increased to US$1000 (H. B. Mayo 2012, s. 375).

Fixed costs relation to the variable cost ratio and the contribution margin ratio

The total contribution margin is the income remaining after covering the total variable costs. It has to be the income that can cover fixed costs and make a profit. Fixed costs are an integral part of the concept of variable costs so here is the explanation of how the proportion of fixed cost to contribution margin affects operating income. There exist three possibilities(M. M. Mowen, D. R. Hansen, D. L. Heitger 2009, s. 121):

1. fixed cost can be equal to the contribution margin;
2. fixed cost may be less than the contribution margin;
3. fixed cost may be bigger than the contribution margin

In the first case operating income should be US$0 (the company reaches the break-even point), in the second possibility the company generates positive operating income. Finally, if the fixed cost is bigger than the contribution margin, then the company incurs an operating loss (M. M. Mowen, D. R. Hansen, D. L. Heitger 2009, s. 121).

References

• Harrison B., Smith C., Davies B. (1992), Introductory Economics, The Macmillan Press Ltd., London, s. 74
• Mayo H.B. (2012), Basic Finance: An Introduction to Financial Institutions, Investments and Management, South-Western Cengage Learning, Mason, s.375
• Mowen M. M., Hansen D. R., Guan L. (2009), Cost Management: Accounting and Control, South-Western Cengage Learning, Mason, s. 613
• Mowen M. M., Hansen D. R., Heitger D. L. (2009), Cornerstones of Managerial Accounting, South-Western Cengage Learning, Mason, s. 121
• Mowen M. M., Hansen D. R., Heitger D. L. (2012), Cornerstones of Managerial Accounting, South-Western Cengage Learning, Mason, s. 114

Author: Radosław Cieślik