Variable cost per unit (VC) is defined as the costs associated with production of a good or service that change frequently. In the business world, variable costs are most frequently used in manufacturing to incorporate the costs of raw materials. As most businesses rely in some part on products with variable costs, however, this concept can be found in the accounting of almost all organizations.
Within the manufacturing world, there are generally two types of costs involved in production. Fixed costs remain relatively constant regardless of how many units are manufactured; variable costs are reliant on the number of units that are made. Facility costs and often labor costs are considered when determining the fixed cost of each unit. Raw materials, packaging costs, and to a lesser extent, utility expenses are factored into the variable cost per unit.
The primary function of VC evaluation is to determine the unit price (UP) of manufactured items. This number is generally added to the fixed business costs in the production of a certain number of units and then divided by the total number of items. The resulting number is the amount for which each unit would need to be sold to break even. Usually, a percentage number is added to each unit to ensure profit. The final dollar amount is the selling price per unit.
Manufacturing a product with a highly variable cost per unit can be risky. While certain raw materials, such as lumber, historically inflate at a fairly predictable rate, certain others are highly dependent on market conditions. Sudden spikes in material costs can raise the costs of a product dramatically. In these cases, manufactures may be forced to either reduce profit margins or offer their product at a price that their customer base may not be able to bear.
Conversely, products with variable costs may be quite profitable. First, prices of manufactured goods do not generally go down. Therefore, consumers do not expect a company to lower its prices because raw materials cost less. Historically, when raw material markets are depressed, manufacturers often experience higher profit margins. In addition, careful stockpiling of resources during these depressions can alleviate the financial impact of sudden rises in material costs.
Potential investors are often very concerned with variable cost per unit when looking at the profit margins of a particular business. Unlike standard business models, the true fiscal growth of manufacturing companies can be skewed by variable costs. Simply put, an increase in profit for these organizations does not necessarily mean a rise in sales, nor does a decrease in profit margins mean that the company is losing customers.
