Guide to Variable Overhead Costs

For owners of businesses both large and small, there are a number of different measures that you should be familiar with in order to measure the financial health of your company. From the working capital ratio to profit margins, you need to get to grips with the various metrics that show your performance. One important figure is variable overhead costs.

In simple terms, variable overhead costs are the manufacturing costs that may vary in relation to the output you are producing. You can use these figures to make estimates of your future expenditures, as well as to calculate how much you should sell your product for. Keep reading to find out more, as well as how to calculate variable overhead cost variance.

What are variable overhead costs?

To begin with, what are variable overhead costs, exactly? In simple terms, these are a way to describe the constantly changing manufacturing costs associated with running your business. There is a direct relationship between variable overhead costs and the production output.

It’s also important to understand about fixed and variable overhead costs.Variable overhead costs differ from other general overhead expenditures which have fixed budgets, known as fixed overhead costs. Fixed overhead costs don’t change according to the level of production. Some examples of fixed overhead costs include:

• Tax and insurance

• Mortgage or rent payments, such as for your factory space or office space.

• Salaries for staff members such as administrators and supervisors

On the other hand, variable overhead costs are those that fluctuate with the level of production, including:

• Raw materials, which tend to fluctuate in price and therefore affect yourdirect material purchase budget.

• The cost of utilities such as water and electricity that are required to run your manufacturing equipment.

• Production supplies

• Wages for staff members who are directly involved in the production process

Variable overhead cost examples

The concept is easier to understand with some variable overhead cost examples. Let’s say you’re running a sneaker company, and you want to figure out your total variable overhead costs. You or your accountants should take a look at all your historical variable costs, including utilities, raw materials and staff wages, and compare this to the units sold.

If you incurred $15,000 overhead costs to produce 7,500 pairs of sneakers, then the variable cost would be $2 per unit ($15,000 / 7500). You can then compare this figure to actual costs and production figures that occur in the following months.

How to calculate variable overhead cost variance

Now that you know about fixed and variable overhead costs, you may be wondering how to calculate variable overhead costvariance. Variance essentially refers to the differences between planned costs and actual costs, so in this case it is a measure of the standard variable overhead costs compared to what was actually incurred.

Luckily, the formula to calculate variable overhead cost variance is quite simple, especially if you have already calculated the standard overhead variance. You simply need to subtract the standard overhead variance costs from actual costs to get this important metric.

Just like other variance measures, standard overhead cost variance can be other favorable or adverse. If the standard costs are less than the actual, then this can be considered favorable variance, since the company is spending less than average for the same production output.

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