What is Cost of Goods Sold?
Cost of Goods Sold (COGS) is the total of all costs for products that have been sold. This includes any costs that are directly related to producing your goods or services. It does not include indirect expenses, such as marketing or office expenses.
Standard costs that go into COGS:
- Cost of materials
- Cost of containers
- Cost of labels
- Cost of labor directly related to making the product
- Shipping costs
- Cost of storing inventory
How to Calculate COGS
To calculate your Cost of Goods Sold, you will need the following information:
- Beginning Inventory – This should be the cost of all your inventory at the beginning of the period. It should be the same as your ending inventory for the previous period.
- Inventory Purchased – This is the total cost of all inventory purchased during the period.
- Ending Inventory – This is the total cost of all products remaining in your inventory at the end of the period. It is always a good idea to do periodic physical inventory counts throughout the year, and certainly on the last day of the year.
COGS = (Beginning Inventory + Inventory Purchased) – Ending Inventory
Why is the Cost of Goods calculation so important?
Understanding Your Profits
Businesses need to know how profitable their product sales are. This ensures that the profit margin they are making is enough for their business to continue operating, and for it to grow effectively.
By understanding your Cost of Goods Sold, you will be able to see how profitable each product is. With this information, you will be able to see if you have “super-star” products (those that cost little to make, but sell for a high margin), as well as those that might not be performing at that level. By knowing your COGS and your profit margin, deciding what products and services to sell becomes much easier.
It is very important to know your COGS for tax purposes. Reporting accurate cost numbers will ensure your tax returns are accurate. Overpaying or underpaying your tax liability happens frequently for those that don’t properly record their costs.
What should you take away from all this?
COGS is extremely important for you to fully understand your small business. For reasons from product selection to taxes, knowing Cost of Goods Sold is critical.