What is a Variable Expense | BankruptcyHQ
There are certain expenses in every business budget that can fluctuate from month to month. Variable expenses are a significant portion of small business spending, unlike fixed costs which stay the same every month. Variable expenses are unpredictable and can make planning difficult for your business budget.
Although budgeting for variable expenses can be difficult, there are some tips you can use to ensure your business doesn’t get in the way. Let’s first define variable expenses and distinguish between fixed and discretionary expenses.
What is a Variable Expense, and How Does It Work?
Variable expenses, also known as variable expenses, vary depending on how often you use a product/service.
Fixed costs, on the other hand, remain constant over a long time. While discretionary expenses can change depending on their use, they are also the extras you enjoy but are not essential to running your business.
Examples of each type of business expense
Let’s look at some examples to help you understand the differences between variable expenses and other business expenses. This will clarify costs fixed and help you know discretionary costs.
Fixed costs:
- Rent
- Insurance payments
- A bank makes the majority of loan payments.
- Subscriptions and dues
- Annual salaries
Variable expenses:
- Utility payments
- Consumption expenses for automobiles, such as fuel and maintenance
- Office supplies
- Professional services are charged per hour
- Hourly employees can get their payroll
Discretionary expenses
- Most entertainment and meals are included in the price.
- Client gifts
- Bonuses and staff parties
Simply put, variable expenses are costs that change. A fixed cost remains the same for a long time. You can also think of discretionary spendings as your “nice to have.”
Variable Expenses are higher than Operating Costs
It is important to remember that while the above lists focus on operating expenses, variable expenses often have a greater impact on your cost of goods sold than any other expense. Variable costs are important for any business that produces products.
This is why it is important. Variable costs of production directly impact your break-even point. The breakeven point of your business is the amount you have to make to cover your monthly expenses. As a business owner, it is important to make more than what you spend.
What Do Variable Expenses Have to Do with My Business Budget?
We now have a better understanding of variable expenses and other business expenses. Let’s look at how variable expense affects your business budget.
Variable expenses are great because you can adjust your production costs to decrease sales or production. They often adjust themselves. Production slows down, and you cease incurring these costs. It is harder to adjust overhead variable costs, such as those mentioned above. This also means that they are more difficult to plan for in your budget.
Let’s look at electricity costs, which is a variable expense that we all can relate to. Your electric bill can vary depending on where you live, what heating options you have, and how much electricity is available. It might be around $100/month during the warmer months or upwards of $300/month during the coldest seasons.
These already variable expenses can also be affected by changing climate conditions. One year could be very mild with winter, but then suddenly it’s cold again.
You can take steps to reduce your electricity bill, such as using a smart thermostat. However, it can be frustrating, especially when you have a revenue slump. (And if you’re manufacturing a temperature-sensitive good, for instance, it’s not like you can just go without heat or cooling to save cash–and we’re sure your workers would agree, no matter what kind of work you do.)
Five Ways to Reduce Variable Expenses’ Impact on Your Budget
As you can see, you may be able to reduce the impact of variable costs by asking your service provider for a fixed monthly amount. This is a simple but effective solution. This fixed amount is calculated based on your average bills over the past 12 months. Many utility companies offer this option to help customers budget. However, a middle payment option will not be available for all variable expenses in your budget.
However, you can still use the average payment method to reduce the impact on variable expenses. Here’s how it works:
-
Calculate the annual average of each variable expense in your budget.
Avoid looking at the last 12 months when calculating the annual average of variable expenses. Review three years worth of variable expenses. This will allow you to account for any anomalies that could affect your average expense. If you have not taken steps to reduce a variable expense permanently, it is best to use the average amount.
-
A buffer is an additional expense.
Add a buffer after you have calculated the average variable expense. A buffer of between 3% and 5% should suffice to cover any price rises or other anomalies that could lead to an unusual year. You can be very cautious if you have the budget to do so.
-
Keep track of your actual spending.
Compare your actual spending for each variable expense with the budgeted amount every month. You should note whether you went over or under budget for each expense category. You can find a Profit & Loss to Budget Comparison Report if you are using business accounting software. You can customize this report to calculate the dollar increase or decrease for you. This would allow you to see in a glance if your budget was exceeded or exceeded.
-
For variable expenses, open a savings account.
This is an essential step in the process. If you’re running short on funds for a variable expense in a given month, transfer the surplus to your business savings account. This will allow you to draw on your reserve for months when your expenses are more than usual. Let’s say that your monthly electric bill is $375.
Your January electric bill was $355 and February’s $325, respectively. March arrives like a lion. A week of below-freezing temperatures causes a March electric bill to be $445. The March bill is typically closer to $245. Business owners budget variable expenses using the actual expense for the preceding year.
You have sufficient money to cover the unexpectedly high March electric bill because you have budgeted $375 per month for electricity ($130 more than the usual monthly electric bill). You would need to quickly find $200 more if you only budgeted $245 for a “normal” March electric bill. This can be difficult for a small business or one that is experiencing a decline in its revenue.
-
Every year, reevaluate your variable expenses.
It is tempting to continue using the same variable expense projections for your budget every year, particularly if you have a substantial amount saved in your variable expenses savings account. This temptation is not to be allowed. Every year, you should review your variable expenses. Especially in expense categories where you have a bit more control than you do with utilities–like automobile usage expenses–opportunities exist to make strategic changes to control the expenses.
Handy Tip: Make sure to capture all variable expenses in your budget
Budget templates are made to match the typical company’s chart. The template will contain fixed costs, variable expenses, and discretionary expenses. This layout makes it easy to compare your actual numbers with your budgeted numbers. (Remember the Profit and Loss To Budget Comparison Report? It also allows you to easily “gloss over” your discretionary and variable expenses while setting your budget numbers.
Start by listing your expenses by type (fixed or variable) when creating your first business budget. Once you’ve determined the amount of each expense, you can add those amounts to your budget template. This will allow you to compare your budget with actual numbers each month easily.
The best way to ensure that variable expenses don’t impact your budget is to pay attention to past expenses and prepare for future expenses. So you don’t get surprised by where you might end up. Averages can be a good indicator of where you’ll land. Keep an eye out for changes, so you aren’t shocked.
Reduce Actual Variable Expenses
We have discussed how to reduce variable expenses’ impact on your finances. But what if your actual variable expenses are increasing? You might consider reducing your variable expenses if your business struggles with predictability or needs to cut costs.
Although we used electricity as an example, most variable costs in your product’s production are related to the actual production. It’s all about labor and materials. If you want to reduce costs, you should analyze the process to see other ways to produce the same output, even if cost-effective modifications are made. Examples include:
- Labor. Can you automate certain tasks? Are you looking to improve the efficiency of your workforce and increase output?
- Materials. Are you able to buy bulk? Would you have fewer problems with your product if you used better materials?
- Evaluation of your product or service. Many companies offer different services and products. Although you could sell a package of products, it is only one part that generates revenue. Do you need to eliminate certain features? Are there ways you could speed up the delivery of your product?
Don’t forget that just because something is done the same way every time doesn’t necessarily mean it’s right. Businesses grow, and you may find yourself overwhelmed. You might not have the time or resources to dismantle your existing systems and processes. This is a good idea because of the volatility in the market and changes in costs. It can help you identify areas where you can save money.
Variable Expenses Can Affect Your Budget, but They Don’t Have to Destroy It
It can be frustrating to create a plan and then have things happen that are beyond your control. Many small business owners don’t budget. It can be difficult to create a budget, especially if your expenses are unpredictable.
With a clear definition of variable expenses, you can easily account for even the most volatile variable expenses with some planning.
To help you keep your budget in line and protect your cash flow, it is a good idea to have a buffer in your business savings account. This will allow you to cover any unexpected variable expenses. You can identify savings opportunities and make improvements to your variable expenses budget by reviewing it annually.