Financial statements are full of valuable information, but some of it gets lost in the shuffle and missed. One of the most critical pieces of financial data that is often overlooked is your company’s Cost of Goods Sold (COGS). This metric is how much your costs are for each item you sell and guides you to know if your pricing is correct. Understanding COGS can make or break your company, and it needs to be included in your tax returns each year. In this article, we’ll explain what COGS is, how to calculate it, and why it’s essential to understand it for your business’s profitability.
What is Cost of Goods Sold (COGS)? Cost of Goods Sold, also known as COGS, are the direct costs of producing the products sold by a company. This amount includes both the labor and the materials used in creating the goods. It does not include anything not directly related to producing a product or delivering a service, such as distribution costs, sales force costs, and any overhead.
Information to Calculate Cost of Goods Sold (COGS) To calculate the COGS, you will need to track down the following data, all of which can be found in your financial documents, or you can consult your CPA for assistance:
- Direct and indirect costs: Discovering all the COGS associated with your business allows you to deduct those costs from the products you sell, whether you manufacture them or re-sell them. Costs include labor, materials, supplies, and other associated costs.
- Determine facilities costs: You must set a percentage of your facility costs (rent, mortgage, utilities, and other costs) to each product for the accounting period in question.
- Determine beginning inventory: Your beginning inventory for the year should be the same as your ending inventory of last year. Inventory includes all products in stock, raw materials, products in progress, finished products, and supplies that are part of the items you sell.
- Add purchases of inventory items: Keep track of all new inventory coming into your business, including packing slips and invoices for every shipment delivered to your business that affects your inventory, especially raw materials.
- Determine ending inventory: Ending inventory is determined by taking a physical inventory of products and materials that remain at the end of the financial period.
COGS = Beginning Inventory + Purchases During the Period – Ending Inventory
Why is COGS important for your business? COGS is a critical metric that can make or break your business.
Here are some reasons why you need to understand COGS:
- Pricing decisions: Setting a selling price for your product is one of the hardest things in business. Knowing your company’s COGS can help you find that sweet spot with your pricing.
- Efficiency of your product: As you begin to calculate and see the whole picture of your COGS, you can improve the efficiency of your product production.
- Differentiate between direct and indirect costs: Understanding COGS and calculating it correctly helps you know the difference between direct and indirect costs.
- Gross profit margin: To calculate gross profit margin, another essential KPI, you will need to know your COGS. Gross profit margin is a ratio used to measure a company’s financial health by revealing the amount of money left over from sales after deducting the cost of goods sold.
As you begin to grasp how to calculate your company’s Cost of Goods Sold, you will also start to understand the crucial role it plays in your business’s profitability. You must charge more for your product than it costs you to create, and accurate financial reporting is key to achieving that goal. That’s where Reach Reporting comes in. Our app can help automate your financial reporting, including your Cost of Goods Sold data, giving you more time to focus on growing your business. With Reach Reporting as your ally, you can stay on top of your financials and make informed decisions that will help you increase profitability and achieve long-term success. So get calculating and try Reach Reporting today!