When your small business makes items or offers services, you need a good way to measure how much each item or service costs so you know how much money you need to make to turn a profit. Cost of goods sold (COGS) lets you calculate total direct costs of the products or services your business sells. This formula includes raw material and supplies costs, direct labour, and direct factory overheads such as utility payments. You report COGS on the second line of your income statement just below sales revenue.
What Is COGS?
Because you use COGS to calculate gross profit and it shows you the true cost of , it’s an important figure for your company to know. Gross profit represents your business’s profit before operating expenses, taxes, or interest payments. You use this basic formula to perform the calculation: COGS = beginning inventory costs + cost of purchased inventory – ending inventory. After you calculate gross profit with this equation: Revenue – COGS = gross profit.
Lets say your company makes widgets. Your inventory at the beginning of the period costs $25,000, you purchase $10,000 in additional inventory during the period, and you end the period with $18,000 in inventory. In this instance, you add $25,000 to $10,000 and then subtract $18,000 from your total. This gives you a COGS of $17,000. This means if you have a $50,000 in sales revenue, you figure your gross profit by subtracting your $17,000 COGS from it for a total of $33,000.
Likewise, COGS can also show you when it might be best to change or pull one of your small business’s products or offerings. For instance, if you have $100,000 in inventory costs, $100,000 in purchased inventory, and $100,000 in ending inventory with sales of just $100,000, you might need to rethink your pricing. This would look like $100,000 + $100,000 – $100,000 for a COGS total of $100,000. When you subtract this from your $100,000 in sales, you get $0 in gross profit.
How Do You Track COGS?
Small businesses, and e-commerce businesses in particular, need to track correct COGS numbers since these figures prove critical to accurate accounting and financial reporting. Accounting software such as QuickBooks Online makes it easier to track your COGS-related expenses, though you still need to organize and keep records that you enter in to ensure you have a clear paper trail in the case of a Canada Revenue Agency (CRA) audit or year-end discrepancies you need to rectify before filing your annual income statement.
When you’re tracking COGS expenses, it’s essential that you include all your direct costs. This means remembering not-so-obvious things like warehousing costs and breaking down production by the lines or shifts that produce them. Time-tracking and payroll apps and modules for accounting software help you accurately log your direct labour costs, while drop-down menus in these programs simplify the process of allocating costs to the correct products.
Remember that many online e-commerce service providers, such as Shopify and WooCommerce, don’t provide business owners with COGS information. This means that you need to track these expenses yourself and maintain accurate records. When you know the cost for every good or service you sell, you can better price your offerings to keep your gross margins high.
Tips on Managing COGS
E-commerce businesses need to keep their gross margins high just like any other business, but they can’t calculate these figures if they only have revenue data. Tracking your sales remains essential, but COGS gives you a deeper dive that compares your revenue to the inventory you have on hand. As a result, COGS lets you decide which products you wish to market, whether you need to raise or lower prices, and if you can afford to keep the inventory you have on hand. This makes redundant tracking and spreadsheets essential for managing your COGS. If you have the information laid out in several formats, reconciling each one to the other ensures you have correct and up-to-date information.
Accurately tracking your expenses and comparing them regularly against your revenue helps you stay in the know concerning your small business’s financial health. Good bookkeeping habits help simplify annual financial reporting and ensures you have exactly the numbers you need when tax time rolls around. Keep your books accurate and up to date automatically. Change the way you manage your finances now.