Cost of Sales (CoS): What is it & How is it Calculated?

The cost of sales (CoS) is a crucial factor for businesses to consider, playing a huge part in maintaining profitability and making sound financial decisions. It refers to the cost of producing goods or delivering services, including everything from raw materials to employee wages. 

The amount that goes into a single sale is a key financial metric to determine a company’s gross profit, helping them track their financial health, set appropriate pricing, and uncover any inefficiencies there may be in their operations. Accounting software can assist in tracking, calculating, and reporting the cost of sales, streamlining this process for businesses and ensuring greater accuracy for such an important metric.

What is the cost of sales?

The cost of sales refers to the costs directly involved in producing goods or delivering services sold by a business. It’s tied specifically to production costs, such as raw materials, labour, travel expenses, or any manufacturing-related overheads. 

As a subset of total expenses, CoS focuses only on the costs that have directly contributed to generating revenue, and it’s an essential figure for understanding and managing a business’ profit margins. By determining how much it costs a business to make what they sell, they’re able to set the pricing accordingly.

Is CoS the same as COGS?

You may also see the cost of sales referred to as COGS, or ‘cost of goods sold’. These are often used interchangeably, but there is a slight difference between the two. COGS is typically the term used by businesses that exclusively sell physical products, such as restaurants or e-commerce platforms. 

Cost of sales, on the other hand, can be used by these businesses as well as ones that provide a service, such as tradespeople or security industries. Find out more about the specific meaning of the cost of goods sold.

How does CoS differentiate from operating expenses?

While the cost of sales refers to costs directly associated with creating a product, operation expenses are the indirect costs involved in running a business. They’re still necessary for operations, but aren’t directly linked to the product or service themselves. Costs such as rent, utilities, and marketing fall under this category. Learn more about operational expenses.

The formula for calculating cost of sales

The cost of sales formula is as follows:

COS = opening inventory + purchases during the period - closing inventory. 

Here’s what that all means in practice:

• Opening inventory: This is the value of inventory your business had at the beginning of the accounting period.
• Purchases during the period: This is the amount of extra inventory or materials bought during this same period.
• Closing inventory: This is the value of whatever inventory you have left over at the end of the accounting period.

This formula ensures you’re only accounting for the inventory that actually generated sales through the accounting period, painting an accurate picture of the cost per sale.

Examples of CoS

To illustrate this, take the example of a retail business selling t-shirts. The figures for a given month are:

• Opening inventory: $20,000 worth of t-shirts in stock at the beginning of the month.
• Purchases during the period: $15,000 worth of additional t-shirts purchased during the month to top up the inventory.
• Closing inventory: $10,000 worth of t-shirts remain unsold at the end of the month.

Using the formula, we can work out that the cost of sales for this month was: 

$20,000 + $15,000 - $10,000 = $25,000.

So, it cost $25,000 to make the total amount of t-shirt sales for the business that month. As a result, the price point for the t-shirts needs to cover this cost, plus a little extra for profit.

Why is cost of sales Important?

As shown in the example above, understanding your cost of sales can help businesses maintain healthy profit margins, making sure they’re charging the right amount for products/services and ensuring the efficiency of their production process. CoS allows them to identify areas where cost-cutting measures can be applied, and also reduces a business’ tax liabilities, since it’s deducted from revenue to calculate taxable income. 

Ultimately, the cost of sales helps a business stay financially agile, making it more efficient, profitable, and sustainable.

Calculating cost of sales for different types of businesses

Different businesses calculate their cost of sales slightly differently, depending on what they sell and how they operate. Here’s a breakdown of how three of the main categories of business would calculate their cost of sales:

Retail businesses

Retail businesses buy finished goods, and then sell them. Since there are no manufacturing fees involved for them, they use the standard cost of sales formula: 

CoS = Opening Inventory + Purchases - Closing Inventory

For example, a furniture shop starts out the month with $20,000 worth of stock, purchases $10,000 of stock throughout the month, and then has $15,000 worth left over at the end of the month. Using the standard formula, this leaves them with a cost of sales of $15,000.

Manufacturing businesses

Manufacturing businesses have a little more to consider, accounting for raw materials, labour, and production overheads. As a result, the cost of sales formula looks slightly different:

CoS = Raw Materials + Direct Labour + Manufacturing Overhead - Closing Inventory

For example, a clothing manufacturer spends $12,000 on the raw fabrics they need that month, $8,000 on the monthly wages of their staff, $5,000 to rent the factory space they use, and finishes the month with $6,000 worth of inventory left over. Using the above formula, this leaves them with a cost of sales of $19,000.

Service-based businesses

For service providers, the cost of sales includes the direct labour and any materials needed to deliver the service. Since there are no physical products to be sold, the opening and closing inventory figures are not relevant. This leaves us with the following cost of sales formula:

CoS = Direct Labour + Materials/Subcontractor Costs

For example, a consulting firm pays their staff $7,000 in wages for the month, and spends $1,000 that month on software needed to deliver a service to their clients. Using the above formula, this leaves them with a cost of sales of $8,000.

Common mistakes in calculating cost of sales

There are a few common mistakes businesses make when manually calculating their cost of sales, leaving them with an inaccurate result. Here are some things to avoid:

• Including operating expenses, like marketing
• Forgetting to consider both opening and closing inventory
• Not accounting for damaged or obsolete stock
• Misclassifying wages of employees
• Failing to track new purchases accurately 

To avoid these mistakes and ensure accurate CoS calculations and reporting, you can use inventory and accounting software to automate all tracking, and reduce human error.

Cost of sales and profit margins

The cost of sales gives businesses more control over their profit margins. Keeping track of it means they can adjust their pricing, sales strategies, and cost-control measures accordingly. For example, if the profit margin is too high, they may need to increase the CoS. If it’s too low, they may want to change their pricing model. 

Cost of sales also has a direct impact on a business’ profitability, with even a small reduction in it markedly boosting profit margins. For example, if a business has a monthly revenue of $50,000 and a CoS of $30,000, their gross profit that month is $20,000. If that business reduced the cost of sales by just $2,000, the new gross profit becomes $22,000, giving a 10% increase in the profit margin. Over time, this will add up significantly.

How accounting software helps with cost of sales

There can be many moving parts in calculating the cost of sales, which often lead to human error. To streamline the process and ensure precision, accounting software can be used to automate the calculations. Through using this, businesses can be more efficient and financially agile, confident that the CoS is accurately reflected and able to adjust their profit margins accordingly.

There are a few ways accounting software streamlines CoS calculations:

• Ensure accurate CoS reporting: Track your inventory and any direct expenses in real-time.
• Reduce the risk of human error: Automate any complex calculations and data entry.
• Insights into CoS trends: Spot notable fluctuations and identify high-cost areas.
• Better decision-making: Use the results to inform pricing, inventory needs, and production strategies.

Track your cost of sales with QuickBooks

Not all accounting software is made equal, with some having more thorough features than others to inform your financial decisions. QuickBooks Online is fully equipped with robust inventory management, real-time financial reporting, and intuitive dashboards, automating and simplifying your cost of sales tracking. 

Gain complete visibility over your business expenses with QuickBooks Online. Get started today.

FAQs on Cost of Sales