Our next step toward understanding profit takes us back to our Thanksgiving pie analogy. If you remember, I am able to figure out ahead of time who would be coming to dinner and how much some of them will eat.
What is left now is the people that are coming that will eat a different amount of pie each year depending on different factors. The biggest factor is how much food there will be for the dinner. If there is more food for dinner, they will eat more dinner and less pie and vice versa.
So if I ask my mother ahead of time how much food she will be making, then I can figure out how much pie each of the remaining people will eat.
This little process is how you figure out your variable expenses. Your variable expenses can depend on several different factors, the most significant of which is the amount of goods or services your business produces each month.
In the analogy, the more food that was produced the less pie each person eats. However, in business this is just the opposite. When you make more widgets in a month, your costs increase. You can figure out just how much each widget increases costs.
The tricky part is figuring out how many widgets your company will produce. In my analogy, I went to my mom and asked her how much food she was going to be making. The same concept exists in the business world. You can go to historical records or ask your team how much product you will be making in a certain period of time, and then estimate the total amount to be produced.
Simple math is then used to multiply the total product by the cost per product to give you the total variable costs for a period of time.