We work with small business owners and entrepreneurs. Some are seasoned, others are just growing their side hustle. Their skills are varied and they have a wide variety of talents. We often get asked to explain the ins and outs of financial reports and have found that providing our favorite clients with a working knowledge of accounting terms is helpful. With that end in mind, we’re sharing that expert knowledge with you. So if you’re looking to get a better grasp on your small business books, want to understand your financial reports so you can make better business decisions, or even are just starting out and want to do it right… you can check out our word of the week and start expanding your working financial knowledge.
What Are Cost of Goods Sold (COGS)?
The Cost of Goods Sold (COGS) is is simply the amount it costs to produce your product or provide your offered services. You may have even heard your bookkeeper or accountant refer to COGS as the cost of sales or services. COGS include both the material and labor expenses that go into production of each good or service sold, so be sure not to leave either piece out.
COGS don’t include indirect expenses like utilities for your building, your marketing expenses, or shipping fees – it’s merely the cost of what it takes to make your product – we’re talking raw material and direct labor on this one. Here’s a simple formula that will give you COGS:
COGS = Beginning inventory + Purchases During the Period – Ending Inventory
Beginning inventory is whatever is left over from the previous accounting period (usually monthly).
Purchases during the period is on the direct labor or raw materials that were paid for during the accounting period.
Ending Inventory is whatever product you haven’t sold by the end of the accounting period.
We mention monthly accounting above, but your particular business could run accounting periods either monthly, quarterly or by calendar years. Make sure you know and take that into account as you’re figuring you’re COGS.
How Does Knowing Your Cost of Goods Sold Help?
To be able to know if you business is turning a profit, you’ll need to know your COGS. Additionally, knowing your COGS can help you better determine the pricing structure for your products or offered services. You’ll also be able to use the number you have for COGS to help you figure out your business’s gross profit or the amount your business earns from your products and services before taking out taxes and other expenses.
If you’re not already tracking the numbers you need to computer your cost of goods sold, it’s time to start. Doing so will help you figure out your COGS as well as help you make your business incredibly profitable.
Frequently Asked Questions (FAQs)
1. What is included in the Cost of Goods Sold (COGS)?
COGS includes the direct costs associated with producing your product or providing your service. This encompasses expenses like raw materials and direct labor. However, it does not cover indirect expenses such as utilities, marketing, or shipping fees.
2. How do I calculate COGS?
To calculate COGS, use the formula:
COGS = Beginning Inventory + Purchases During the Period – Ending Inventory
- Beginning Inventory: The amount of inventory left over from the previous period.
- Purchases During the Period: Costs of raw materials and direct labor incurred during the current period.
- Ending Inventory: The value of inventory that remains unsold at the end of the period.
3. Why is knowing my COGS important for my business?
Knowing your COGS is crucial because it helps you determine your business’s profitability. By calculating COGS, you can better set pricing for your products or services, assess your gross profit, and make informed financial decisions to enhance profitability.
4. How often should I calculate my COGS?
The frequency of calculating COGS depends on your accounting period, which could be monthly, quarterly, or annually. Regularly updating your COGS helps you maintain accurate financial records and make timely business decisions.
5. What should I do if I’m not currently tracking my COGS?
If you’re not tracking your COGS, it’s important to start as soon as possible. Begin by documenting your beginning inventory, tracking purchases, and updating your ending inventory. This will help you compute COGS accurately and manage your business finances more effectively.
