Managing costs effectively is key to running a successful small business. While fixed costs like rent and insurance remain constant, variable costs—expenses that change with production or sales—fluctuate with business activity. Understanding and managing these costs can significantly impact your bottom line, particularly during uncertain economic times influenced by inflation or supply chain disruptions.
Variable costs are expenses directly related to business activity. When sales or production increase, these costs rise; when sales decline, they fall. Their flexibility distinguishes them from fixed costs, which remain stable regardless of business performance.
Examples of variable costs:
For small businesses, variable costs often appear on financial statements as the Cost of Goods Sold (COGS), which is the direct expense related to delivering products or services.
Fixed costs are expenses that remain constant regardless of production, such as rent, administrative salaries, or loan payments.
Variable costs are expenses that rise or fall in direct proportion to business activity, such as raw materials or delivery fees.
Semi-variable costs include both fixed and variable components, such as electricity fees with a base charge plus usage costs.
Example: A small restaurant pays monthly rent (fixed cost), purchases ingredients to create inventory that fluctuates based on sales (variable cost) and pays a part-time employee a base wage plus overtime during busy seasons (semi-variable cost).
Variable costs adjust in real-time with sales and production, providing flexibility during slow periods but adding pressure when business picks up. Rising input costs from inflation—like raw materials or transportation—further complicate cash flow management. Without careful monitoring, businesses risk shrinking profit margins and cash shortages.
A recent survey of Canadian accountants revealed that 54% of accountants view inflation as the most significant financial threat to small businesses. Interestingly, the survey also found that, of the mistakes small business owners make, the second biggest is ‘not paying enough attention to cash flow.’
Inflation increases input costs, such as raw materials, transportation, and energy. For instance, the price of flour for a bakery or lumber for a carpenter can rise unexpectedly, impacting cash flow.
Regular assessment
Supply chain optimization
Improve inventory management
Operational efficiency
Adjust Pricing Strategies
To maintain resiliency, monitor your cash flow weekly, plan for seasonal fluctuations, and build cash reserves to absorb unexpected cost spikes.
Adaptive budgeting
Adaptive budgeting creates a financial plan that flexes with your business needs rather than remaining static. Monitor for changes—like rising costs or shifting sales patterns—and adjust accordingly.
Example: A restaurant owner noticed food costs rising. Instead of accepting lower profits, they:
By setting clear financial triggers—such as 25% profit drops or costs rising above a set percentage—you can respond quickly and avoid bigger problems.
Learn more about financial forecasting.
The bottom line
Managing variable costs is essential for small businesses to protect cash flow and profit margins, especially during economic uncertainty. As a business owner, you can remain resilient and competitive by tracking costs, negotiating better terms, and improving operational efficiency. Taking proactive steps to control costs today ensures you’ll build the resiliency required for long-term success.