Cost of Goods Sold (COGS) is among business leaders’ top crucial accounting terms. COGS encompasses all direct costs associated with manufacturing products. Knowing COGS and managing its components could be the difference between running your business with a profit or being on the spinning hamster wheel.
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What is the cost of goods sold?
Your cost of goods sold Cost of Sales, or service price is how much it is to make your company’s products and services. COGS include the following charges:
- Direct labor
- Materials needed to create good
The cost of the goods sold comprises the costs associated with manufacturing the item or service you offer (e.g., screws, wood, paint labor, etc.). Therefore, when calculating the cost of items sold, don’t include the costs of making items or services that aren’t sold.
COGS does not include other indirect expenses like distribution costs. So, for example, don’t consider marketing costs, utilities, or shipping charges in the price of goods sold. Also, COGS only includes manufacturing costs.
Importance of COGS in business
Then, why is the cost of selling goods crucial to your company? The answer is that your COGS will provide you with many details, including:
What is your profit over a time
If you have to alter the price of your services, do it.
If you’re spending too much money on expenses to make the product or service, you’re spending too much on costs to produce the product or
You can also utilize the cost of selling goods to determine your company’s gross profit. When you know your gross profit, you can determine the net profits, which is the sum your company earns after deducting all costs.
- Understanding your company’s earnings will help you:
- Make financial decisions
- You should look for funding (e.g., a business loan)
- Consider if you’ll need to make changes
Pricing your services and products is one of your largest responsibilities as a business owner. Similar to Goldilocks, you must discover the price that’s the right price for your products or services. If you don’t, you’ll have to pay for losses.
If your product’s price is too high, you could experience a decline in sales and interest. On the other hand, if you sell your products at a price that is at a low price, you may not earn enough money.
To determine the ideal price for pricing, consider the cost of items sold. When you clearly understand your COGS, you can determine prices that will give you an acceptable profitability margin. You can also determine when prices for a specific product should be increased.
Your COGS can also inform you that you were spending excessively on production costs. The more expensive your production costs are, the more you’ll need to sell products or services to make profits.
If your production costs are high, seek ways to cut back on costs, like choosing the right supplier.
What’s in the cogs and what’s not
You should first consider how you can precisely determine your inventory cost and, consequently, COGS. It’s important to know the costs you incur. They are included in your item cost (inventory on your balance sheet) that will eventually show as the COGS line on your earnings statement once your product sells.
Making sure you have this number correct is essential to determine your gross margin. It is a vital number that is essential to every company. Many companies fail due to their margins being too small.
- Price of the product – the amount you pay your vendor to purchase the items you offer.
- Freight in – what was it to bring the item delivered to the warehouse(s)?
- Charges and fees – any additional costs incurred to transport the item to you.
- You must pay the freight out costs to deliver the item directly to customers.
- Tooling fees are the costs for the tooling.
- R&D- Costs to study and develop the product before it is ready to market.
How to calculate cogs
The cost of selling goods (COGS) is determined by taking the cost of inventory held at the beginning of the period to be studied, adding the cost of any new inventory bought during the period, then subtracting the inventory value at the conclusion of the period.
Formula for cogs
COGS = Beginning Inventory + Purchases – Ending Inventory
COGS can be used to establish a business’s cost to purchase or produce the entire range of products it sells during an epoch. This is crucial since it has a major impact on the profitability of a business for a specific time.
How COGS will benefit your e-commerce business
Particularly for businesses with high transactions, real-time insight into COGS numbers allows you to negotiate terms for payment and incentive deals with your vendors. Volume discounts will not only boost profitability but also improve the flow of cash if your volume discount is an incentive to cash.
Budgeting and cash forecasting become more precise with COGS visibility. The ability to slice and cut COGS into the current as opposed to. Prior period amounts are crucial for accurate financial reporting. The monthly accruals and timing problems can cause margins to be distorted. Knowing what’s really affecting sales and how to correct prior mistakes in the period provides additional confidence to forecast and budget purposes.
Know the direction your money is taking. If COGS is not in alignment with expectations, all departments from the supply chain, accounting accounts payable, accounting, and sales have to be in the process. It’s a team attempt to relay the tale of what transpired with COGS. For example, did accounting not recognize accrual or over-accrued expenses? Did sales or finance estimate the wrong mix of products? Or is it a tech problem in which our systems were not synchronized with the vendor’s systems? COGS analysis fuels these conversations to ensure that management and employees are in sync with the driving forces that are behind COGS changes.
How do you cut down COGS and improve the margins of your e-commerce business?
If you’re looking to cut down on your company’s COGS, there are many methods to go about it. Based on the circumstances and needs, reducing COGS could be more beneficial rather than raising costs (or you can combine both). Here we will go over some of the main strategies, but be aware that not all of them are applicable to your particular situation.
- Utilize economies of scale when you can. No matter if your products come supplied by a third party or you’re manufacturing them on your own, as your store grows, you should consider getting discounts when you buy in bulk.
- Switch suppliers, manufacturers, or materials completely. If you’re negotiating with the companies that you’re working with based on economies of scale isn’t not working, consider looking at alternative options. It could be as simple as choosing a supplier offering lower shipping costs and a cheaper material to manufacture or outsourcing manufacturing.
- Check out the products which aren’t making sales. Even if they have an impressive margin, it will negatively impact your COGS when they’re merely sitting on shelves. Consider ways to reduce the rate of turnover or even eliminate these items completely.
- Eliminate bottlenecks and mistakes within the supplier chain. There are a lot of possible improvements after analyzing the supply chain. Examples include damaged materials or goods lost due to the current process of shipping or labor inefficiencies.
- Automate as many workflows as you can. As an accounting solution, it is important to remember how important automation is. If labor costs comprise the majority of your business’s costs, then automation can have a significant impact. This might mean replacing an existing process with a machine or even introducing software to help your staff to improve efficiency.