The ‘Cost of Goods Sold‘ (COGS), or ‘cost of sales‘, are those costs which are directly attributed to the manufacture of goods to be sold by a company. Obviously, this amount includes the cost of those products and raw materials used in creating the good. However, it also include more indirect expenses, like staff wages, factory overhead, and the costs involved in distribution. The cost of goods sold figure is a prominent part of a profit and loss statement. When deducted from total revenues, it can calculate a company’s gross profit margin.
A common mistake is to assume that cost of goods sold cover all of a company’s expenses, from the creation of the product to its sale. However, COGS actually only refers to the costs of making the products. The cost of retail is accounted under ‘expenses’, a separate figure on an income statement. For example, for a large shoe retailer, the cost of goods sold would include the material costs for the shoes, along with the cost of labour used to put the shoe together, and the factory overheads. However, the cost of sending those shoes to their retail outlets, and the wages of retail staff would usually be excluded. They are unrelated to the costs of production.
Common Expenses Classed As Cost Of Goods Sold:
Listed below are the most common costs which comprise the COGS figure.
- The cost of raw materials/products used, including shipping or freight expenses;
- Product storage costs;
- Production worker wages;
- Factory rent and other overheads, electricity cost etc.
How Is The Cost Of Goods Sold Calculated?
There are multiple ways to calculate COGS. Perhaps the simplest is to use the following equation:
(Beginning Inventory + Inventory Purchases) – End Inventory = Cost of Goods Sold
Let’s break it down a little bit to understand what’s going on here.
The beginning inventory, when added to the amount of inventory purchased over the period you’re accounting for, provides the total amount of inventory that could theoretically be sold. This combined figure is sometimes known as the Cost of Goods Available for Sale.
We then subtract the ending, or actual, inventory balance from that figure. What this effectively does is show us the price of only the goods we have actually sold. The difference between the cost of goods we could have sold, and the cost of goods we have at the end of an accounting period, is the cost of the goods we sold during that period!
Let’s consider an example: imagine you have an e-commerce business selling posters. Your inventory count at the beginning of July, the month you’re going to account for, is £1,400 worth of posters. During the month, you stock up on some more rare copies – £600 worth of limited edition stocks. At the end of the month, your recount shows that your inventory is £1,300.
Using the equation, your Cost of Goods Sold for July is £700, calculated as follows:
Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold
£1,400 + £600 - £1300 = £700
Hold your horses. Sadly, things are not always so straightforward, and the exact costs included in the COGS calculation do differ from one type of business to another. Furthermore, there are some things cost of goods sold cannot account for; theft of goods, for example, as the equation cannot distinguish between goods stolen and those sold, though the difference in inventory will still show up the same way. Make sure you understand how cost of goods sold has been calculated before taking an accountant’s word as gospel!
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