The variable cost of goods sold (COGS) refers to the portion of the cost of producing goods that varies with the level of production or sales. It includes the direct costs directly attributable to the production or acquisition of goods, which fluctuate based on the volume or activity level.
Variable costs of goods sold typically include the following components:
- Direct Materials: These are the costs of the raw materials or components that are directly used in the production process. The cost of direct materials can vary based on the quantity of materials used in manufacturing.
- Direct Labor: This represents the wages or salaries paid to the workers directly involved in the production process. Direct labor costs are considered variable because they are dependent on the number of labor hours or workers required to produce the goods.
- Variable Manufacturing Overhead: Variable manufacturing overhead costs include expenses such as utilities, supplies, and maintenance that directly vary with the level of production. These costs are directly associated with the manufacturing process and can fluctuate based on production volumes.
By including only the variable costs in the calculation of COGS, the variable COGS isolates the costs that vary with the level of production or sales. This allows companies to analyze the impact of changes in production volumes or sales levels on their cost structure and profitability.
It’s important to note that the variable COGS does not include fixed costs, such as rent, depreciation, and salaries of management personnel. Fixed costs remain constant regardless of the production volume within a certain range. Including fixed costs would provide a complete picture of the total COGS, but it would not specifically reflect the variable portion of the costs.
Understanding the variable COGS is crucial for determining the breakeven point, analyzing cost-volume-profit relationships, and making pricing decisions based on the variable cost structure. By identifying and managing variable costs effectively, companies can optimize their cost management strategies and improve their overall profitability.