Easy But Efficient Steps to Calculate Cost Of Goods Sold (COGS)

Your financial statements are a critical piece of document which essentially can’t be ignored. And of course, there are terms and figures that can be breezed over without ado. However, one thing that cannot be ignored is the Cost of Goods Sold aka COGS. Yes! We know that you realise how imperative COGS can be for tracking the financial fundamentals of your business. But have you ever wondered how businesses keep a tab of their inventory and calculate their profits? Well, the answer lies in how they calculate their Cost of Goods Sold.

The COGS calculation is necessary for running a business, as it allows you to keep track of your inventory and determine your profits. Therefore, in this post we will show you how to calculate cost of goods sold for your business and turn tables towards your trade’s profitability.

What Is Cost Of Goods Sold (COGS)?

The cost of goods sold (COGS) is an important metric used in accounting to measure the direct costs associated with producing a good or service. COGS includes the cost of materials, labor, and other direct expenses incurred in the production process. COGS does not include indirect expenses such as overhead or marketing. How to calculate cost of goods sold?

In order to calculate COGS, businesses must track the cost of each good or service they produce. This information can be tracked manually or through accounting software. Once the cost of goods is known, businesses must then subtract this amount from their total revenue to calculate their gross profit. COGS is an imperative metric for businesses to track as it provides insights into the efficiency of their production process and overall profitability. In addition, by understanding their COGS, businesses can make informed decisions about pricing, production, and other strategic decisions.

What Is Included In Cost Of Goods Sold?

The cost of goods sold is the direct costs associated with producing the goods or services you sell. These costs are sometimes referred to as the "cost of sales." The cost of goods sold includes:

  • The cost of materials and labor directly used to create the product and the cost of any packaging and shipping.
  • If you're a retailer, it also includes the cost of the goods you purchased from your suppliers.

The cost of goods sold is deducted from revenue to calculate a company's gross profit. From there, overhead and other expenses are deducted to calculate net income. For many businesses, the cost of goods sold is the largest expense on the income statement. That's why it's important to carefully track and manage these costs.

The purpose of COGS is to give managers and investors a better understanding of the true cost of production and to help them make more informed decisions about pricing and other strategic issues. When calculating COGS, it is important to use accurate and up-to-date information to get an accurate picture of the associated costs. By understanding what's included in the cost of goods sold, you can make decisions that will help improve your business's bottom line.

What Are The Exclusions From COGS?

The Exclusions from COGS are numerous and complex. In order to be sure that all the right elements are covered, business owners should ask their accountant or financial advisor for help in determining which costs can and cannot be included in the calculation. Generally speaking, though, the following items are not considered to be part of COGS:

  • Materials that have not yet been used in the production process
  • Unfinished products
  • Shipping and handling
  • The cost of storage
  • The cost of insurance
  • Overhead expenses such as rent and utilities
  • Marketing and advertising
  • Research and development

By excluding these costs, businesses can better understand the actual cost of manufacturing and selling their products.

How To Calculate Cost Of Goods Sold (COGS)?

The cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company. To simplify, it is the cost of the materials used in making a product minus the cost of any finished products that are later resold. Calculating COGS is important for several reasons.

  • First, it can give you a better understanding of your company's profits.
  • Second, it can help you price your products more effectively.
  • Finally, it can assist you in making decisions about production levels and inventory management.

There are two key elements to calculating COGS:

  • Direct materials: Direct materials are the costs of production materials, such as raw materials, packaging, and components.
  • Direct labor: Direct labor consists of the wages paid to workers who are directly involved in production, such as factory workers and assembly line workers.

In order to calculate COGS, businesses must track the cost of each good or service they produce. This information can be tracked manually or through accounting software. Once the cost of goods is known, businesses must then subtract this amount from their total revenue to calculate their gross profit.

    **<span style="text-decoration:underline;">Total Revenue - Gross Profit= COGS </span>**

For example: If a company has total revenue of $100,000 and a gross profit of $20,000, its COGS would be $80,000. Therefore, the implied calculation would look like this:

        **<span style="text-decoration:underline;">$100,000 - $20,000= COGS</span>**

Note: Remember that COGS does not include indirect costs, such as overhead or marketing costs. These expenses are recorded separately on a company's income statement.

What Is The Difference Between Beginning Inventory And Ending Inventory?

Beginning inventory is the cost of goods a company had at the beginning of the accounting period. Ending inventory is the cost of goods a company had at the end of the accounting period. Perhaps, the difference between these two amounts is the cost of goods sold.

    **<span style="text-decoration:underline;">Beginning Inventory - Ending Inventory = COGS</span> **

How To Calculate Purchases?

Purchases are calculated by adding the cost of goods purchased during the period to the beginning inventory and subtracting the ending inventory.

Beginning Inventory + Goods Purchased - Ending Inventory = Purchases

For example: If a company has a beginning inventory of $10,000, purchases goods worth $5,000 during the period, and has an ending inventory of $2,000, their purchases would be $13,000.

    **<span style="text-decoration:underline;">$10,000 + $5,000 - $2,000 = $13,000</span>**

What Is The Difference Between COGS And Operating Expenses?

COGS only includes the direct costs associated with producing the goods or services you sell. Operating expenses are all the other costs businesses incur to keep their doors open and running smoothly. These costs include rent, utilities, insurance, marketing, and office supplies. While operating expenses are important to track, they are not considered part of COGS.

        **<span style="text-decoration:underline;">Direct Costs of Production = COGS</span>**


**       <span style="text-decoration:underline;"> Operating Expenses = All Other Business Expenses</span>**

By understanding the difference between these two types of costs, business owners can get a clear picture of their true profits.

Steps To Calculate Cost Of Goods Sold (COGS)

To figure out how to calculate cost of goods sold, businesses must start step by step. Like:

  • First, track their inventory levels. This process begins when goods are purchased or manufactured and continues until the goods are sold.
  • Businesses must then estimate the value of their remaining inventory at the end of the accounting period.
  • The cost of goods sold is then calculated by subtracting the ending inventory from the beginning inventory, and adding any costs associated with acquiring or producing the Goods.
  • The resulting figure reflects all of the costs that have been incurred in order to sell Goods during the accounting period.

By taking the time to calculate your COGS, you can get a better understanding of your company's overall profitability. Additionally, by understanding these costs, businesses can make more informed decisions about pricing and production.

Example Of Cost Of Goods Sold

The cost of goods sold (COGS) is the direct costs associated with producing the goods or services that a company sells. It includes the cost of materials, labor, and any other direct expenses. COGS does not include indirect expenses, such as overhead and marketing. The goal of a business is to sell its products or services for more than it costs to produce them, and the difference between the selling price and the COGS is known as the gross margin.

COGS is important because it represents the largest expense for most businesses and directly impacts a company's profitability.

To calculate COGS, businesses must track the costs associated with each product or service they sell. This information can price products appropriately and make strategic manufacturing, inventory, and other operations decisions. While COGS can be difficult to track, it is essential to running a successful business. Some examples to finely understand the Cost of Goods Sold are added below. Have a look:

Example 1: If a company has a beginning inventory of 100 widgets at a cost of $5 each and sells 60 widgets during the period, its ending inventory would be 40 widgets (100 + 0 - 60).

The company's COGS would then be $300 ($5 x 60).

To calculate gross profit, simply take the revenue from sales and subtract the COGS.

In this example, gross profit would be $700 ($1,000 - $300). If a company has no ending inventory, its COGS will equal its total purchases for the period.

Example 2: If a company has no beginning inventory and buys 100 widgets during the period for $5 each, its COGS will be $500 ($5 x 100). In this case, gross profit would equal $500 ($1,000 - $500).

It's important to note that the cost of goods sold can fluctuate from period to period depending on changes in inventory levels. Therefore, companies usually report their COGS on a monthly or quarterly basis.

Choosing An Accounting Method For COGS

Two major accounting methods are used to calculate the cost of goods sold (COGS):

  • The absorption costing method

Under absorption costing, all manufacturing overhead costs are included in the COGS calculation. This includes fixed costs, like rent and utilities, and variable costs, like raw materials and labor. The advantage of this method is that it gives a more accurate picture of the true cost of producing a good or service. However, it can also result in higher taxes, as more of the company's income is considered taxable income.

  • The variable costing method

Under variable costing, only the direct costs of producing a good or service are included in COGS. This includes raw materials and labor but not fixed costs. The advantage of this method is that it results in lower taxes, as less of the company's income is considered taxable income. However, it can also give a less accurate picture of the true cost of producing a good or service. As you can see, there are pros and cons to both methods.

However, with times changing, the old traditional ways have been sidelined by new ways of accounting methods for COGS. Some of them are added below:

FIFO

"First in, first out" (FIFO) is an inventory valuation and costing method that assumes that the oldest products in a company's inventory have been sold first. The costs associated with the first units purchased are assigned to the first units sold. FIFO provides a very accurate costing of inventory and cost of goods sold (COGS) when used in conjunction with a perpetual inventory system.

FIFO is considered to be the most logical and easy-to-understand inventory valuation method. While FIFO results in higher COGS in periods of rising prices, it results in lower COGS in periods of falling prices. This leads to more accurate financial statements because it more closely matches revenues with the actual costs of goods sold.

The main advantage of using the FIFO method is that it more accurately matches revenues with expenses. This matching gives decision-makers a better understanding of the profitability of each sale. In addition, because FIFO assigns the most recent costs to inventory, it provides a better estimate of the current replacement cost of inventory. This information is useful when making decisions about pricing, product mix, and production levels.

LIFO

LIFO stands for Last In, First Out. This accounting method assumes that the last inventory items to come in are the first ones sold. Therefore, the cost of goods sold (COGS) is calculated by taking the most recent inventory items and subtracting them from the beginning inventory.

The LIFO method is often used because it more accurately reflects the current cost of inventory. This is especially important in industries where prices are constantly fluctuating. For example, if the price of wheat increases, the COGS for a bakery will go up if they are using the LIFO method. This gives a more accurate picture of the business's expenses.

On the other hand, LIFO can also lead to artificially high profits during periods of inflation. This is because older, cheaper inventory is being used to calculate COGS. As a result, businesses may be tempted to switch to a different accounting method during periods of high inflation. While this may not always reflect reality, it can be advantageous for tax purposes because it results in a lower cost of goods sold and, therefore, higher profits.

Average Cost Method

The average cost method is a common way to account for the cost of goods sold (COGS). Under this method, businesses add up the total cost of all the inventory they have purchased over a period of time, and then divide that number by the number of units they have in stock. This gives them an average cost per unit, which is then used to value the COGS for each sale.

The main advantage of the average cost method is that it is relatively simple to calculate. However, it can be less accurate than other methods, such as specific identification, because it does not take into account differences in quality or price between different batches of inventory. As a result, businesses may want to use a more sophisticated method if they have complex inventory needs.

Special Identification Method

The special identification method (SIM) is a costing method used to determine the cost of goods sold (COGS). This method assigns specific costs to each unit of production, making it easy to track and identify expenses. The SIM is often used in manufacturing businesses, with a clear link between raw materials and finished products. To calculate COGS using the SIM, businesses first need to track the cost of raw materials and other direct costs associated with each unit of production. These costs are then allocated to the finished product based on the number of units produced.

As a result, the SIM provides a more accurate picture of COGS than other costing methods, making it an important tool for businesses that need to closely track their expenses.

While the cost of goods sold can be difficult to calculate, it's essential to running a business. By understanding the different methods available and choosing the one that best suits their needs, businesses can ensure they accurately track their COGS and make the best decision for their company.

How Is COGS Different From Cost Of Revenue And Operating Expenses?

This is a question that often comes up in business, particularly when organizations are trying to track their financial performance. So here's a look at the key ways COGS differs from cost of revenue and operating expenses.

Sr. No Cost of Goods Sold Cost of Revenue
COGS is the direct costs associated with the production of the goods that a company sells. The cost of revenue is the total cost of generating revenue, including both direct and indirect costs.
COGS includes the cost of the materials, labor, and any other direct expenses. Operating expenses are all a company's expenses that are not related to production, including marketing, administration, and rent.
COGS does not include indirect expenses, such as marketing or administration. COGS is a subset of the cost of revenue, and both are subsets of operating expenses.

Thus, COGS is the smallest category, followed by cost of revenue, and then operating expenses. Companies use this information to analyze their business and make decisions about where to allocate their resources. For example, if a company wants to increase profits, it might focus on reducing COGS or increasing revenue while keeping operating expenses constant.

Cost of Revenue vs. COGS

When reading a company's financial statements, you may come across the terms "cost of revenue" and "cost of goods sold" (COGS). These two concepts are related but not identical. So let's look at the differences between the two.

  • The cost of revenue includes all the costs associated with generating revenue, while COGS only includes the cost of goods sold. For example, if a company manufactures widgets, the cost of the raw materials used to make the widgets would be included in COGS.
  • However, if the company incurs other costs in its widget-making process, such as factory overhead or employee salaries, those expenses would be included in the cost of revenue. When evaluating a company's financial health, it is important to consider both costs of revenue and COGS.

By looking at both figures, you can get a complete picture of a company's expenses and how they relate to its sales.

Operating Expenses vs. COGS

Businesses have operating expenses (OpEx) and cost of goods sold (COGS). The difference between the two are:

  • Operating expenses are the costs of running the company, such as rent, utilities, salaries, and marketing. COGS are the direct costs of producing the product or service, such as raw materials, labor, and packaging.
  • Operating expenses are typically fixed costs that cannot be easily reduced, while COGS can sometimes be reduced by renegotiating contracts or using lower-cost suppliers.

Knowing the difference between these two types of expenses is important for managing cash flow and making strategic decisions about where to allocate resources.

What Are The Limitations of COGS?

COGS, or Cost of Goods Sold, is a measure of the direct costs associated with producing a product or service. This includes the cost of raw materials, labor, and overhead expenses. While COGS is a useful metric for assessing the profitability of a business, it has some limitations. They are:

  • COGS does not include indirect costs, such as marketing or administrative expenses. This can make it difficult to accurately understand the true cost of producing a product or service.
  • COGS can vary significantly from one period to the next, making it difficult to compare apples to apples.
  • Because COGS only includes direct costs, it does not reflect the potential revenue that could be generated from selling a product or service.
  • Because there is no standard way of calculating COGS, businesses often have different ways of calculating it, making it difficult to compare results across companies.

For these reasons, COGS should be used in conjunction with other financial metrics when evaluating the profitability of a business.

How Can Fincent Help in Calculating COGS?

Fincent’s COGS module can be a valuable tool for businesses that want to keep track of the costs of goods sold. The module allows businesses to input data on the costs associated with each item they sell, including materials, labor, and overhead.

This information can then be used to generate accurate reports on the overall cost of goods sold. As a result, businesses can use the Fincent COGS module to make sound financial decisions regarding pricing, inventory management, and profit margins. Therefore, the ways are added below to help you understand how Fincent can aid you with your business(es) COGS report. Have a look:

Understand Inventory Costs

Inventory management is vital for any business, especially businesses that sell physical products. To make informed decisions about inventory levels, it is essential to understand the full cost of goods sold (COGS). This includes not only the cost of the raw materials but also the labor and overhead costs.

Fincent can help business owners track these costs and clearly understand their COGS. With this information, they can make more informed decisions about pricing, production, and inventory levels. In addition, Fincent can help businesses to manage their cash flow and reduce their overall costs. Therefore, it is an invaluable tool for business owners who want to optimize their inventory management.

Obtain Accurate Cost Data

Being able to track your inventory and cost of goods sold (COGS) is a crucial holding, and Fincent can precisely help you with that. Such information is important for businesses because it helps them decide on pricing, production, and inventory levels. By having accurate information about your COGS, you can ensure that you are making enough profit to cover your expenses and grow your business.

Fincent can also help you track other aspects of your finances, such as sales and expenses. This information can help make decisions about where to allocate your resources.

In addition, the Fincent can help you keep track of your customer's payment histories and creditworthiness. This information can be used to decide whether to extend credit to a customer or how much credit to extend. By using Fincent financial software, you can obtain accurate and up-to-date information about your business finances, helping you make better decisions about your business.

Track Inventory Costs

It is important to clearly understand your inventory costs for businesses that sell physical products. This information is critical for calculating your cost of goods sold (COGS), which is a key metric for determining profitability. Historically, tracking inventory costs has been a time-consuming and error-prone process, but Fincent can help. It tracks the cost of each unit of inventory from when it is purchased until it is sold, and the data can be easily exported into Excel for analysis. In addition, Fincent can also track inventory levels in real time, which can help businesses avoid stockouts and excess inventory.

Calculate Average Cost per Unit

Fincent can help business owners and managers calculate their average cost per unit, which is an important part of calculating their cost of goods sold (COGS). To calculate the average cost per unit, businesses need to know the total cost of all the units they produced during a period of time, divided by the number of units produced.

This information is important because it helps businesses price their products correctly and understand their profitability. Using Fincent, business owners and managers can save time and ensure that their calculations are accurate. In addition, it can help businesses track their costs over time, so they can see trends and make changes to improve their bottom line.

Determine Total COGS

There are several things that go into the calculation of your company's cost of goods sold (COGS). Your total COGS includes the cost of all the raw materials that went into making your product and any labor costs associated with manufacturing it. In addition, your total COGS also includes any shipping and handling costs incurred in getting the finished product to your customers.

Fincent can help you keep track of all these different costs so that you can accurately calculate your COGS. By inputting all your raw materials costs, labor costs, and shipping and handling costs into the software, you can get a clear picture of your total COGS. This information is essential in determining your company's profitability and making smart business decisions.

Final Takeaway!

Calculating your cost of goods sold (COGS) is vital to running a successful business. It helps you understand your company's profitability and make smart decisions about pricing, production, and inventory levels.

Fincent can help you track all the necessary data and information to accurately calculate your COGS. In addition, the software can also help you track other aspects of your finances, such as sales and expenses. This information can be used to decide where to allocate your resources.

By using Fincent, you can save time and ensure that you have accurate and up-to-date information about your business finances. So, go ahead and give Fincent a try today!