Gross profit is an important indicator of the profitability of the enterprise, which determines its ability to turn one dollar of income on one dollar of profit, after accounting for all expenses directly related to producing goods or services for sale. The formula of gross profit is simply revenue minus cost of goods sold, or cost.
Cogs is a very specific financial concept that includes only those business expenses that are necessary for the production of goods such as raw materials and wages for labour which is necessary for the creation or Assembly of the product. Other expenses necessary to conduct business, such as rent and insurance fees are not included. Cost consists of fixed costs and variable costs, which in turn have a big impact on gross profit.
What Are Variable Costs?
Variable costs are expenditures that increase or decrease depending on the number of produced products. For example, to produce 100 rocking, the company may need to purchase a value of $2000 of lumber. For production of 1000 rocking chair, needs lumber is much higher, making it a variable cost.
Other variable costs include wages for direct labour, transportation costs and Commission.
What Are The Fixed Costs?
Fixed costs are costs that do not vary depending on production levels. This does not mean that these costs are written in stone – sometimes rent goes up or insurance premiums to go down. Instead, the term “fixed” refers to the absence of correlation between flow rate and quantity of manufactured goods. If the company makes 100-rocking or 1000 rent for the use of factory or warehouse in any case.
Other common fixed costs the cost of advertising costs, salaries for hired employees or those whose wages do not change with production level, payroll taxes, employee benefits and office supplies.
Determination of cost of goods sold
It is clear from the definition of fixed versus variable costs that a figure of cogs consists of both types of costs. Some businesses find COGS to include all variable costs and all fixed costs are considered under overheads. A more realistic approach is the inclusion of the direct costs associated with the production of goods, regardless of category.
Total variable costs included in the cogs figure the cost of raw materials, other materials necessary for production, wages for labour needed for the production of goods and utilities for the facility where manufacturing occurs. The total fixed costs included in the calculation of the cogs, the salaries for Supervisory employees, required to ensure the quality of products and equipment the depreciation costs.
How fixed and variable costs affect gross profit
Both fixed and variable costs have a large impact on the gross profit, and its more complete counterpart, operating profit. The increase in costs necessary for the production of goods for sale means lower gross profit. This is important because without a healthy gross profit, strong profit margins, a comprehensive result, is unlikely.
Gross profit is the first indicator of profitability, the company’s revenues, and profitability trickle down from this figure. Thus companies seek to reduce fixed costs and variable costs to maintain the profit at each level.