Definition: The Variable cost is the cost proportionally related to the level of output, i.e. it increases with the increase in the production and contracts with the decrease in the total output. Simply, the cost which varies with the change in the total output is called the variable cost.
The most common form of variable costs is raw material, direct labor related to the level of output, sales commission, and the cost of all other inputs that vary with the total production. For example, if the company pays 3% sales commission for every sale made by the salesperson, then 3% is the variable cost which varies with the change in the sales volume.
The variable costs and Fixed costs together make up the total cost of the firm. Symbolically,
Total Cost = Fixed Cost + Variable Cost
The company with the higher proportion of variable costs than the fixed costs can generate higher profit margins, even at low sales. But, however, as the sales increase the profit margin generated will be less than that would have been generated with the higher fixed cost. Thus, the variable cost is essential for projecting the profits of the firm and calculating the break-even point of the business or project.
Also, the higher variable costs encourage the new entrants to enter the market, thereby increasing the competition.