We work with small business owners and entrepreneurs. Some are seasoned, others are just growing their side hustle. Their skills are varied and they have a wide variety of talents. We often get asked to explain the ins and outs of financial reports and have found that providing our favorite clients with a working knowledge of accounting terms is helpful. With that end in mind, we’re sharing that expert knowledge with you. So if you’re looking to get a better grasp on your small business books, want to understand your financial reports so you can make better business decisions, or even are just starting out and want to do it right… you can check out our word of the week and start expanding your working financial knowledge.
What Are Cost of Goods Sold (COGS)?
The Cost of Goods Sold (COGS) is is simply the amount it costs to produce your product or provide your offered services. You may have even heard your bookkeeper or accountant refer to COGS as the cost of sales or services. COGS include both the material and labor expenses that go into production of each good or service sold, so be sure not to leave either piece out.
COGS don’t include indirect expenses like utilities for your building, your marketing expenses, or shipping fees – it’s merely the cost of what it takes to make your product – we’re talking raw material and direct labor on this one. Here’s a simple formula that will give you COGS:
COGS = Beginning inventory + Purchases During the Period – Ending Inventory
Beginning inventory is whatever is left over from the previous accounting period (usually monthly).
Purchases during the period is on the direct labor or raw materials that were paid for during the accounting period.
Ending Inventory is whatever product you haven’t sold by the end of the accounting period.
We mention monthly accounting above, but your particular business could run accounting periods either monthly, quarterly or by calendar years. Make sure you know and take that into account as you’re figuring you’re COGS.
How Does Knowing Your Cost of Goods Sold Help?
To be able to know if you business is turning a profit, you’ll need to know your COGS. Additionally, knowing your COGS can help you better determine the pricing structure for your products or offered services. You’ll also be able to use the number you have for COGS to help you figure out your business’s gross profit or the amount your business earns from your products and services before taking out taxes and other expenses.
If you’re not already tracking the numbers you need to computer your cost of goods sold, it’s time to start. Doing so will help you figure out your COGS as well as help you make your business incredibly profitable.