Variable Margin: Definition and Calculation

What is Variation Margin?

Why should you calculate the variable margin?

With variable margin, you can choose how much to charge for your goods and services in a more strategic way. Performing the variable margin calculation is advantageous in the following ways:

Helps make pricing decisions

Variable margin can be used to examine variable production costs. For instance, having a low or negative variable margin indicates that your business or product may not be as profitable as you had hoped. It is therefore best to modify its current sales price level.

Evaluates items profitability

Although you shouldn’t use variable margin to gauge a company’s overall profitability, you can use it to evaluate the profitability of a specific product and work out the best way to increase it. You can decide to increase the product’s price or decrease the variable production costs based on your evaluation to increase profitability.

Resolves bottlenecks

Variable contribution can be used to pinpoint production line bottlenecks and identify which of your products is the most lucrative and, consequently, worth continuing to produce. Products with high variable margins fall into this category.

Helps with break-even analysis

You can determine the break-even point—the point at which a company covers its fixed costs but doesn’t make a profit—by calculating the variable margin. To do this, multiply the variable margin ratio by the sum of the fixed expenses. You can determine how many units you need to sell in order to break even by calculating the break-even point in units.

What is variable margin?

The margin left over after deducting variable production costs from revenue is referred to as the variable margin, also known as the variable contribution margin or contribution margin. While a product’s variable costs are taken into account by the variable margin, any related fixed costs are not.

Variable margin formula

You must first determine the sale price of the goods or services and the variable costs before calculating the variable margin. Once you have these two numbers, use the formula below to determine the variable margin:

Sales price – variable costs = variable margin

Use the following formula to determine the variable margin as a ratio:

(Sales price – variable costs)/sales revenue = variable margin ratio

What are variable costs?

Direct and indirect costs incurred during the production and sale of a company’s goods or services are referred to as variable costs. Remember that variable costs fluctuate based on the volume of goods or services a company sells. As a result, variable costs rise with rising production and fall with falling output volume. Here are some examples of variable costs:

Comparatively, fixed costs are expenses that don’t change as the volume of goods and services produced does. One-time costs for things like machinery, for instance, are regarded as fixed costs because they remain the same regardless of how many products are sold.

How to calculate variable margin

You can begin calculating the margin for your company now that you are familiar with the variable margin and its formula. Making this calculation will assist you in comprehending the idea and its various applications. The steps listed below can be used to determine a product or service’s variable contribution margin:

1. Find the product or services sale price

Find the sale price of the specific good or service you want to use as the basis for your calculation. Let’s say, for instance, that a business is selling a pair of pants for $10. The sale price in this scenario is $10.

2. Determine the variable costs

Recognize the variable costs, which are those that change in direct proportion to the volume of units sold. For instance, if you’re figuring out the variable margin for a product, your variable costs might be commissions and direct materials, while they might be commissions, payroll taxes, and the cost of labor for services.

3. Subtract variable costs from the product or services sale price

To calculate the variable margin, use the following equation along with the data from the first two steps:

Sales price – variable costs = variable contribution margin

Remember that you can also use this formula to calculate a percentage as a ratio. To determine this, multiply the above difference by the sales price:

Variable contribution margin is equal to (Sales price – Variable Costs) / Sales price.

Be sure to eliminate expenses like factory overhead, such as rent or machinery maintenance, as well as any selling and administrative costs.

Examples of variable margin calculations

To better understand variable contribution, consider the following two examples:

Example 1

Consider the situation where you want to calculate the variable contribution margin for the sale of a new product. The product sells for a price of $30. Materials cost $4, inbound freight costs $1, and a sales commission of $5 make up its variable costs. Using these figures, you can calculate the variable contribution margin.

Keep in mind that you must add up the cost of materials, inbound freight, and sales commission in order to calculate the variable costs. To calculate the variable contribution margin, perform the following calculation:

Sales price – variable costs = variable contribution margin

$30 – ($4 + $1 + $5) = $20

Therefore, you have a variable contribution margin of $20. This represents the margin available to pay for fixed costs.

Example 2

Let’s say a business makes $500,000 in sales and spends $200,000 on variable costs. Calculate the variable margin by dividing $500,000 by $200,000 This results in a variable margin of $300,000. The remaining $200,000 is used to cover your fixed costs. Divide the $200,000 by the quantity of units sold to get the “per product” margin.

Variable margin vs. gross margin

Although you can measure your company’s profit margins using both the variable margin and the gross margin, each calculation has a different purpose. For instance, variable margin enables you to identify which overhead costs have an impact on your profits while gross margin enables you to monitor your profits on your inventory.

Additionally, the variable margin excludes factory overhead costs, whereas the gross margin does. Included factory overhead costs substantially reduce your margin. Therefore, it is less useful when making incremental pricing decisions to use gross margin information from a margin analysis because it includes allocated overhead costs.

FAQ

What are variable margins?

The margin left over after deducting variable production costs from revenue is referred to as the variable margin, also known as the variable contribution margin or contribution margin. While a product’s variable costs are taken into account by the variable margin, any associated fixed costs are not.

What does variable margin tell you?

The margin that results when variable production costs are deducted from revenue is known as the variable contribution margin. It is most helpful for determining incremental pricing when a company must pay its fixed costs as well as some of its variable costs.

How do you calculate margin over variable cost?

1. Net Sales – Variable Costs = Contribution Margin.
2. Contribution Margin Per Unit = (Product Revenue – Product Variable Costs) / Units Sold
3. Sales Price Per Unit / Contribution Margin Per Unit Equals Contribution Margin Ratio

How do you increase a variable margin?

Companies can improve contribution margins by increasing operational efficiencies ways. You could invest in more productive machinery to make the same number of widgets in less time, lowering variable product costs. Additionally, the business might adopt lean manufacturing or better operational procedures.