Total variable cost is the aggregate amount of all variable costs associated with the cost of goods sold in a reporting period. It is a key component in the analysis of corporate profitability. The components of total variable cost are only those costs that vary in relation to production or sales volume. Typically, the only costs considered to be elements of total variable cost are:
- Direct materials. These are the materials that are part of a finished product, or the production supplies that are consumed in the production process, and which can be traced to specific manufacturing activities.
- Commissions. Only include the cost of commissions when they vary directly with sales. Thus, any fixed commission component, such as a quarterly bonus, should be excluded.
- Freight in. It is usually possible to trace the specific costs associated with delivering direct materials to the production facility, which qualifies them as variable costs.
Direct labor is not usually considered an element of total variable cost, since it rarely changes in direct response to production volumes; one exception is piece rate wages, which do change with production volumes. Most direct labor is used to staff a production line; the line must be manned, irrespective of the number of units processed.
If a company is in the services business, then direct labor is likely to be the largest component of its total variable cost. This is because billable hours comprise most of the cost of goods sold, along with the related costs of payroll taxes and employee benefits.
Total variable cost is used as a line item in an income statement that is organized in a contribution margin format, where only variable costs are included in the calculation of the contribution margin.
Total variable cost is not compiled at the individual unit level.