Average Variable Cost Formula (Table of Contents)
What is the Average Variable Cost Formula?
The term “average variable cost” refers to the variable cost of production that is expressed in terms of per unit of production. The variable component of the perunit production cost primarily comprises direct labor rate, raw material cost per unit and variable manufacturing overhead per unit. The formula for average variable cost can be derived by adding raw material cost, direct labor cost, and variable manufacturing overhead and then dividing the result by the number of units produced. Mathematically, it is represented as,
Examples of Average Variable Cost Formula (With Excel Template)
Let’s take an example to understand the calculation of the Average Variable Cost Formula in a better manner.
Average Variable Cost Formula – Example #1
Let us take the example of XYZ Ltd. to illustrate the calculation of the average variable cost. The entity is a shoe manufacturing company in the state of Ohio. According to the annual report published for the year 2018, the following cost information is available:
 Total raw material cost: $5 million
 Labor cost: $10 per hour
 Number of man hours required: 300,000 hours
 Total variable manufacturing overhead: $1 million
 Number of shoes manufactured: 60,000
Calculate the average variable cost of production for XYZ Ltd. based on the given information.
Solution:
Direct Labor Cost is calculated using the formula given below
Direct Labor Cost = Labor Cost Per Hour * Number of Man Hours Required
 Direct Labor Cost = $10 per hour * 300,000 hours
 Direct Labor Cost = $3,000,000
Average Variable Cost is calculated using the formula given below
Average Variable Cost = (Raw Material Cost + Direct Labor Cost + Variable Manufacturing Overhead) / Number of Units Produced
 Average Variable Cost = ($5 million + $3 million + $1 million) / 6,0000
 Average Variable Cost = $150
Therefore, the average variable cost of XYZ Ltd. for the year 2018 is $150 per unit.
Average Variable Cost Formula – Example #2
Let us take the example of ABC Ltd., which is a corrugated box manufacturer. Last year, the company gradually increased its production volume to check at what point the variable cost breaches the selling price. Accordingly, the following cost and production data is available, Calculate at which level of production the average variable cost breaches the selling price if the selling price is $9 per box. Also, plot the graph for average variable cost against the production volume.
Solution:
Average Variable Cost is calculated using the formula given below
Average Variable Cost = Total Variable Cost / Number of Boxes Manufactured
For 10,000 Boxes
Average variable cost _{10,000 }= Total variable cost / Number of boxes manufactured
 Average variable cost _{10,000} = $81,500 / 10,000
 Average variable cost _{10,000} = $8.15
For 15,000 Boxes
 Average variable cost _{15,000 }= $120,000 / 15,000
 Average variable cost _{15,000 }= $8.00
For 20,000 Boxes
 Average variable cost _{20,000 }= $156,000 / 20,000
 Average variable cost _{20,000 }= $7.80
For 25,000 Boxes
 Average variable cost _{25,000 }= $200,000 / 25,000
 Average variable cost _{25,000 }= $8.00
For 30,000 Boxes
 Average variable cost _{30,000 }= $247,500 / 30,000
 Average variable cost _{30,000} = $8.25
For 35,000 Boxes
 Average variable cost _{35,000 }= $295,750 / 35,000
 Average variable cost _{35,000 }= $8.45
For 40,000 Boxes
 Average variable cost _{40,000 }= $350,000 / 40,000
 Average variable cost _{40,000 }= $8.75
For 45,000 Boxes
 Average variable cost _{45,000 }= $409,500 / 45,000
 Average variable cost _{45,000 }= $9.10
For 50,000 Boxes
 Average variable cost _{50,000 }= $462,500 / 50,000
 Average variable cost _{50,000 }= $9.25
Therefore, from the above analysis, it can be concluded that somewhere between production levels of 40,000 boxes to 45,000 boxes the average variable cost breached the selling price. It is advisable not to increase the production beyond that level.
Explanation
The formula for average variable cost can be derived by using the following steps:
Step 1: Firstly, figure out the overall raw material cost expensed in the manufacturing process during a certain period. The raw material cost depends on the quality of material used, the rate per unit quantity and the amount used.
Step 2: Next, figure out the cost of direct labor that is directly related to the manufacturing process. The direct labor cost depends on several factors like level of expertise, labor rate and a number of production hours.
Step 3: Next, figure out the variable manufacturing overhead of the company and it includes all the variable costs that are left and can be directly apportioned to the manufacturing process.
Step 4: Next, determine the number of units manufactured during the period and it depends on the production level.
Step 5: Finally, the formula for average variable cost can be derived by adding raw material cost (step 1), direct labor cost (step 2) and variable manufacturing overhead (step 3) and then dividing the result by the number of units produced (step 4) as shown below.
Average Variable Cost = (Raw Material Cost + Direct Labor Cost + Variable Manufacturing Overhead) / Number of Units Produced
Relevance and Use of Average Variable Cost Formula
It is important to understand the concept of average variable cost as it is very pivotal to the profitability of a company. Typically, a company can drive its profit margins efficiently through effective management of the variable cost. However, the average variable cost is indirectly governed by the law of diminishing marginal returns and as such, it decreases with the increase in production volume to a certain point, beyond which it starts to escalate with the increase in production volume. Therefore, variable cost influences the production plans because it only makes business sense to continue increasing production volume until the point where the average variable cost is less than the average selling price.
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Average Variable Cost Formula Calculator
You can use the following Average Variable Cost Formula Calculator
Raw Material Cost  
Direct Labor Cost  
Variable Manufacturing Overhead  
Number of Units Produced  
Average Variable Cost  
Average Variable Cost = 
 

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