During any financial review, variances against plans are always items of intense discussion and require in-depth analysis. When I look at these discussions, I often see how the window of time to unearth the cause of variances is critical. And, of course, this analysis usually occurs during the month-end close process, when things are most hectic.
I know it would be ideal if actual results during the year matched what we initially planned. However, we all know that business changes are typical after budgets are established, leading to variances and necessary explanations. In my experience, variance analysis typically involves comparison across multiple time periods or benchmarks.
In this article, I’ll walk you through manufacturing COGS variances (i.e., variances in costs of goods sold) versus the annual budget. I’ll also share actionable ways to analyze and break down the components of these variances.
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Key Takeaways
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Table of Contents
- First, What is COGS?
- COGS Variance Component 1: Volume Variance Analysis
- COGS Variance Component 2: Mix Variance Analysis
- COGS Variance Component 3: Rate Variance Analysis
- Determining Total COGS Variance
- COGS Variance is Complicated – Choosing Support Tools & Resources Doesn’t Have to Be
1. First, What is COGS?
Cost of Goods Sold (COGS) refers to the direct costs of all components used during the manufacturing process. Researching COGS variances without a complete understanding of where to look (or without the right tools) can lead you down long and time-consuming paths.
Three main components make up a COGS variance: volume, mix and rates.
- Selling more volume of any or all products than planned will generate a volume variance and affect overall cost. You will see when we talk more about volume variance analysis that as simple as this calculation may seem, you’ll need to take a few steps to separate out the mix component to truly see volume variance.
- Mix occurs when a variety of products are sold at a different volume than planned. Mix variance analysis looks at how the product is weighted, or distributed, amongst its total population. For example, let’s say we sold 100 cans of corn in the total sales volume of 1,000, or 10%, while the plan called for a sale of 8% of canned corn. This mix change of 2% at the canned corn level creates an unfavorable cost variance, or as we say, mix variance.
- Rate fluctuations happen for a variety of reasons and are typically unexpected. Changes can occur, for example, with increases or decreases in vendor pricing on material purchases or in transportation and warehousing costs. Based on the bill of material (BOM), these rates can affect some or all products and have a direct impact on overall costs, which would create a rate variance.
It’s very likely that the impact of your manufacturing process’s COGS variance is driven by all three components. Over the next few sections, I will outline how to calculate volume, mix and rate. This should help you determine how cost changes are affected by multiple expense drivers, thus enabling you to decompose the volume and pricing performances.
2. COGS Variance Component 1: Volume Variance Analysis
Before we explore volume variance, let me first explain the meaning of volume. In the manufacturing industry, volume is most often used to either describe the level of production units produced or sales units sold.
Production units produced drives total cost of production (COP), which flows to the balance sheet until sold. In our discussions here, we will be referring to the sales units produced, which drives COGS and appears on the profit and loss statement. Therefore, an increase in sales volume equates to higher COGS, which will have a direct impact on gross margins and company profits.
(As a note, keep in mind that there is a latency between a unit that is produced and sold, which can be anywhere from 2-4 months due to logistics constraints, shipping time, customs, etc.)
Naturally, more or less units sold will drive COGS up or down accordingly and reflect on the profit and loss statement, which will result in a variance. To determine the key drivers behind the variances, we must first break down the volume sold by product type and analyze both budget and actual. This will help us see the variances for each product type.
COGS Volume Variance Formula
Once we have analyzed it in this way, we then calculate the volume variance using this formula:
Volume Variance = (Plan Quantity – (Total Actual Quantity * Plan Mix)) * Plan Rate
Volume Variance Analysis Example
In the example below (Illustration A.1) from ABC Canning Co., we see a condensed P&L with COGS in an unfavorable variance from budget totaling -$6.7M or -28.2%. This alarming, unfavorable variance will inevitably lead to questions.
As mentioned previously, explaining COGS variances is best approached by analyzing the impact by volume, mix and rate, which will help explain the driving factors. When seeing a COGS variance, the questions to ask are:
- How much of the additional cost is related to volume?
- How are the different weighting of product types having an impact on mix?
- And what is the cost impact on the fluctuations on rates and cost changes?
The chart below (Illustration B.1), further analyzes COGS variance by product type, showing volume, cost and price rate for both budget and actual, revealing the total variance of -$6.7M.
To determine how much of the -$6.7M is related to volume, we apply the calculation described above to each product type as shown in the chart below (Illustration B.2). As the chart below shows, of the total -$6.7M COGS variance, the total volume impact is -$3.8M.
The logic behind the volume variance calculation is to separate:
- Actual mix by applying the actual volume with budget mix, and
- Actual rate by applying the actual volume with budget rate.
To analyze further, if there is no volume change, then there is no mix impact, because the sales volume and mix were at planned levels. However, if total volume is the same, but the individual product volume differs from plan (i.e., creating a mix), then there would be no volume impact, but the individual products would have a mix impact.
3. COGS Variance Component 2: Mix Variance Analysis
The purpose of mix variance analysis is to see how much of your total COGS variance is due to producing products at a volume different from what was initially planned. The objective is not to compare total volume sold, but instead compare the distribution percentage, or weighting, across all the products that were sold in the time span.
It’s important to note that mix variance will not exist when there is only one product type. With only one product type, variance would come from volume, not mix or rate. Mix variance is created whenever two or more products are included in a product group.
In this analysis, we’ll use budgeted price rate to better isolate actual rate differences and see the true mix impact. This approach reflects the fact that not all products are created (i.e., sold ) equal. A higher or lower sales volume from plan will change the mix in comparison from plan and have a direct impact on COGS. To summarize this concept:
- Selling a higher volume than planned of higher-cost products will generate a high mix and have a negative impact on COGS
- Selling a lower volume than planned of lower-cost products will generate a low mix and have a positive impact on COGS
Mix Variance Formula
When performing this analysis, use this mix variance calculation:
Mix Variance = (Actual Quantity * (Actual Mix – Plan Mix)) * Plan Rate
Mix Variance Analysis Example
Using a similar data set below (Illustration B.3) for ABC Canning Co. and using the calculations noted above, we can see mix has an impact on COGS totaling -$228K. Canned corn is causing most of this mix variance at -$252K.
Looking further into this product, we see that the planned mix was 38% and actual sales mix was 39%, resulting in a 0.6% increase. Applying this mix increase in our mix calculation shows the change in volume impact was -445K units, which we then multiply against the budget rate of $0.57, resulting in our final mix impact of -$252K.
The logic behind mix variance analysis is to keep total actual volume as-is and focus on the additional costs as it relates to the products’ actual sales distribution in comparison to plan.
4. COGS Variance Component 3: Rate Variance Analysis
The third and final variance analysis, Rate Variance, is the change in rate and its impact on cost. If the cost of a product is higher or lower in a given period than what was planned, then this higher or lower rate is a Rate Variance.
As noted previously, rate fluctuations can occur for several reasons, including:
- Vendor price increases on material purchases,
- Transportation fee increases on driver wages,
- Higher demurrage charges, and
- Warehousing cost increases.
These rate changes have a direct impact on overall costs and will create a Rate Variance. Rate Variance directly affects the profitability of a product or service because it changes the cost structure of operations. For example, if vendor prices increase due to inflation or supply chain disruptions, businesses may face unplanned cost overruns, which impact margins. Similarly, transportation fee increases—driven by fuel costs or driver shortages—can ripple through a company's logistics network, increasing the overall cost of goods sold (COGS). These unanticipated rate changes not only create immediate cost variances but may also influence strategic decisions, such as whether to pass increased costs to customers or absorb them to remain competitive.
To manage Rate Variance effectively, organizations often rely on strategies such as renegotiating vendor contracts, seeking alternative suppliers, optimizing supply chain efficiency, or leveraging financial hedging tools. Regular variance analysis can also provide early warning signals, enabling businesses to address rate fluctuations proactively. By monitoring trends and identifying the root causes of Rate Variance, businesses can make informed decisions to minimize its impact on profitability and long-term sustainability.
Rate variance formula
The calculation for deriving a Rate Variance is as follows:
Rate Variance = (Planned Rate – Actual Rate) X (Actual Quantity)
Rate Variance Analysis Example
By returning to our example from ABC Canning Co. below (Illustration B.4) and laying out costs for both budget and actual, we see the different rates by product type.
Canned corn, for example, was budgeted to cost $0.57/can, while the actual cost was $0.65/can, or a $0.09/can increase. Although it may sound immaterial, when applying these rates against the millions of units sold, we create a large variance that would cause concern for both management and shareholders.
Overall, the actual cost of goods sold totals $30.3M and is over plan by $6.7M. How much is related to rate changes? Applying our calculation above results in a total rate impact of $2.6M, which is simply the difference in rate x actual units sold.
From the list of products below, it appears that canned corn has the highest impact. As mentioned before, the rate increase of $0.09/can result in a cost increase of $2.6M (or 39%) of our total $6.7M variance. It appears that this is where most of the focus needs to be moving forward. But what exactly is causing the cost on canned corn to spike?
The logic behind rate variance analysis is simple and requires no special calculations, as we saw above.
We simply:
- Find the rate difference between plan and actual, and
- Multiply the difference against the actual volume.
Note: If the actual rate had no change, then there wouldn’t be a rate variance.
5. Determining Total COGS Variance
As mentioned previously, all three variances (i.e., volume, mix and rate) can also exist. Nevertheless, no matter how many variances exist, the summation of all the variances must equal the total COGS variance. The chart below (Illustration C.1) illustrates this by showing how the variances for volume, mix and rate total to the COGS variance of $6.7M.
The graph below (Illustration D.1) also represents the variance impacts of volume, mix and rate by demonstrating a “variance walk” from plan to actual. This is another useful visual tool to present to management to help guide and explain the breakdown of the COGS variance.
To go further, additional commentary can be explained on each. For example, we might comment on rate analysis based on our above finding that the price on canned corn increased $0.09/can, resulting in a total cost variance of $2.6M or 39% of the overall COGS variance.
6. COGS Variance is Complicated – Choosing Support Tools & Resources Doesn’t Have to Be
It is easy to simply point at volume as a cause for the additional cost, but as we see in the analysis above, volume is not always the cause. Like an onion, we need to peel away the layers and separate out the causes so that management can better understand fluctuations, ask better questions and make more informed decisions.
Understanding the impact that volume, mix and rate can have on COGS variance is key. Such analysis is pivotal for any manufacturing company that desires to fully understand the extent of their COGS variance.
Leveraging modeling tools like the ones described above—will help any finance professional during the month-end close, which is a crucial time for any business.
8020 Consulting Can Help Enhance Your Variance Analysis Process
Effectively managing variances, including Rate Variance, is crucial for maintaining financial control and optimizing profitability. Our team of experienced financial consultants can work with you to strengthen your variance analysis processes, identify cost drivers, and implement strategies to improve decision-making and operational efficiency.
