Strategy Session

What Are Variable Costs?

revenue variable cost Jul 14, 2022

One question that always comes up is what our variable costs?

And it's kind of a strange item that would continuously come up. But it's so important because variable costs are a key driver of profitability in your business.

So what are variable costs?

Variable costs are the costs that are incurred directly related to delivering your revenue. So for example, if you're buying and selling books, right, you sell a book for $10. The actual costs, the variable costs associated with driving that revenue is the purchase of the book or the manufacturer of the book. So let's say the book is $4, the revenue is $10, your gross profit is $6. Why do we need to know the $4? Because we don't understand how much money we're making in driving new revenue without having a really good understanding of what the costs of delivering that revenue are.

It's super important that we have a good understanding of our variable cost not only now, but how we continue to manage them so they don't grow in value. So what I mean by that is, again, back to our book example, $10 sale of a book. We have $6 in gross profit.

What happens if that book all of a sudden costs $8?

How do we respond to that in our business?

Which is super important because if all of a sudden we went from making $4 for every book down to $2 for every book, that cuts our gross profit in half and it could have a very negative impact on our bottom line. Having a really good understanding of our variable cost is a key element and a critical driver to strong financial performance in your business.

So one thing that we can do inside our business to make sure we're monitoring our variable costs is to review our financial performance on a month to month basis. So what this would look like would be we pull up our bookkeeping software, our preferred provider is QuickBooks online. We pull the profit and loss reporting sequence that would show us all of the months, maybe the last six months, month to month.

And what we would do is we would look at the gross profit margin and the variable costs associated with revenue every single month.

Why would we do that?

We want to make sure that our profitability continues to rise on every sale. If it starts to go down, it means that our costs associated with delivery are increasing and we have to make adjustments inside our business so that we don't end up having a negative financial performance.

So the first step would be making sure that your financial information is up to date. Make sure your bookkeeping is relevant and current and analyzing those reports to make sure that we're understanding how our variable expenses are changing, whether it's a positive or a negative, and make sure that we stay on top of them to really drive a strong financial performance in your business.

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