# How To Understand the Variable Cost Ratio

Costs are inevitable in any business. Every component in a business incurs costs. For a layman, cost can just be as simple as the amount of money a business pays to be able to operate. For those who are well-versed in accounting and commerce, however, costs are subdivided into different groups. Before you discover what variable cost ratio is, it is best to first understand what variable cost is.

Variable costs are the expenses that change depending on the activity of the business. It is the exact opposite of a fixed cost. Businesses that are labor-intensive tend to have higher variable costs than those that are mainly capital-intensive. The reason for this is that even when the demand for a product lessens, there is no more chance to limit the costs of labor and raw materials because the products have already been made. The fixed cost is not affected by the supply or demand activities. Even when the demand for the product increases, fixed costs like rental and business taxes will still remain the same.

To give you a clearer picture of what variable cost is, imagine a manufacturing company that produces jeans. The variable costs that this manufacturing company will have will depend on the number of jeans they have produced. Sewing more jeans will need more clothing supplies to be used. It will also mean more manpower. More sewers may be employed or over-time hours may be logged. It will also mean more usage of energy like water and electricity. All of these variable costs contribute to the total variable cost of producing jeans. Lower the amount of jeans to be produced and the levels of these factors will follow. However, even if you lower the amount of jeans to be produced, the rental or lease (if any) for the manufacturing plant and the business taxes paid by the company will still remain fixed.

Meanwhile, a variable cost ratio is the result when you divide the total variable costs with the total sales. It can also be computed by subtracting the contribution margin (CM) from 1.

Example:

 Total Ratio Sales \$6000 1 Less: Total Variable Costs \$1500 0.25 or 25% Contribution Margin \$4500 0.75 or 75%

Imagine that the table above illustrates the sales that the jeans manufacturing company had for a week of production. The equation used for computing the variable cost ratio is this:

Total Variable Cost ÷ Total Sales = Variable Cost Ratio

\$1500 ÷ \$6000 = 0.25 or 25%

The other way of computing for variable cost ratio is by using this equation:

1 - Contribution Margin = Variable Cost Ratio

1.00 - 0.75 = 0.25

The contribution margin is also known as the marginal income. It is the amount of money that the company allocates for fixed costs or the amount that is to be considered as profit.

Determining the variable cost ratio is of importance to a business. As you can see, the variable cost ratio is a part of determining the profits of the business. It is also needed in computing for a break-even analysis.

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