COGS, which stands for Cost of Goods Sold, is an important factor to consider to understand whether your business is making profits. It helps to gain an accurate understanding of your expenses and will help you in making more informed decisions when establishing the prices of your products. In this article, we’ll explore everything you need to know about COGS and why it’s important for your business.
What is COGS?
COGS refers to the total money spent by a business to procure the goods that were sold during a specific period of time. This encompasses not only production costs but also all expenses connected to developing finished inventory or, if you are not manufacturing your own products, the cost related to buying products destined for sale.
How do you calculate COGS?
(Beginning Inventory + Purchases) – Ending Inventory = COGS
Beginning inventory: At the beginning of your fiscal year, what is the cost of all your product inventory? This should correspond to the ending inventory from the previous fiscal year.
Purchases: The total cost of all products procured during the fiscal year that are available for sale, inclusive of raw materials, as well as those not included in starting or closing inventory.
Labour costs: Expenses of employees directly involved in the product assembly process (excluding administrative staff).
Materials and supplies costs: All costs related to the creation of the products you are selling.
Additional costs: Any other expenses not previously accounted for, including shipping containers, freight for materials and supplies, rent, utilities, hardware, software, etc.
Ending inventory: The total value of all remaining items in inventory at the end of the fiscal year.
Why is COGs important
Making informed strategic decisions
When you know exactly how much it costs to procure or produce your goods, you are able to make more informed decisions. For instance, if after calculating the COGS, you find that it is higher than your profits, you know you need to identify areas where costs can be improved or you can try and negotiate better deals with suppliers.
Strategically pricing your products
An additional advantage of calculating your COGS is that it provides insight into how you can establish your product pricing. By knowing your COGS you can determine the desired profit margin for your products. Also, if you have a low COGS you can strategically price your products to be more competitive in your industry.
How a eLogy’s WMS can help with COGS
Maintaining accurate records of your inventory at the beginning and end of each year is of utmost importance. Remember that your inventory comprises not only the finished products ready for resale but also all the raw materials you possess, any items that are in progress but not yet completed, and any supplies. As you do for your personal taxes, it is necessary to keep all documentation to verify these items were purchased during the appropriate fiscal year. How can one manage inventory?
Maintaining precise inventory records is a very complicated process that can be simplified using an Inventory Management System thanks to which you will have:
Accurate tracking of inventory: By accurately tracking all your inventory, from the time it is received until it is sold, a WMS will make sure you keep track of all costs associated to each item, from starting to ending inventory.
Real-time data: Thanks to real-time information on your inventory levels, you can make timely decisions on procurement and production, ensuring that the COGS is calculated based on the most recent and precise data.
Tracking additional costs: apart from purchasing or producing costs, there are many other expenses related to your goods, like shipping and warehousing, that a WMS will accurately manage for you.
Historical data: given the frequent fluctuations in the costs of raw materials or other direct costs, a WMS historical data feature is essential to maintain accurate records of your expenses.