When a business consistently sells goods and services, it’s easy to assume they’re profitable. However, it’s not cut and dry. Consistent sales don’t mean a business is breaking even and making profit. Cost of goods sold is a calculation that can help a business determine how profitable they really are and how much their good costs to produce.
What Is Cost of Goods Sold?
Cost of goods sold is a calculation that takes into account nearly every expense required for a business to create a product or service. That includes the cost of manufacturing items and labor.
Other examples of items included in the cost of goods sold calculation are:
- Materials used
- Items purchased for resale
- Factory labor
- Shipping costs
- Packaging
- Storage costs
- Commissions for salespeople
It’s important to also know which costs aren’t included in the calculation. Examples include marketing, rent, insurance, admin costs, utilities, or buying equipment to produce products. Mostly, things that are considered overhead costs aren’t factored into the COGS calculation.
Knowing the cost of goods sold is helpful because it can give businesses an accurate picture of their expenses, costs of production, and an idea of how much it will take to break even and begin being profitable.
Cost of goods sold can be found on a business’ income or profit and loss statement and is typically located below “sales” or “income.”
The Importance of Cost of Goods Sold
Every company hopes to be profitable. To measure their profitability, companies need measurements, which is where COGS can be helpful. Companies may also use the calculation to determine the pricing of their products or services.
Not only is COGS helpful to business owners, but it can also help analysts and investors estimate a company’s bottom line. When the cost of goods sold is high, a business’ net income typically decreases. Likewise, when COGS is on the lower end, a business’ net income is usually high. This is significant information for investors as the less income a business has, the less they have to give shareholders.
Calculating COGS
To calculate cost of goods sold, use the following formula:
Beginning inventory + Inventory costs – Ending inventory = Cost of goods sold
Here is a brief breakdown of each measurement.
- Beginning inventory: The cost of the goods sold at the start of the measured time period
- Inventory costs: Additional production costs incurred during the measured time period
- Ending inventory: The cost of inventory that doesn’t get sold at the end of the measured timeframe
COGS can also be measured over a period of a year, quarter, or month.
Cost of Goods Sold Example
Let’s say John owns a suit line and is trying to measure the cost of goods sold in 2022. He produced goods worth $50,000 at the start of the year, making that his beginning inventory. In June, he ordered materials worth $15,000 to produce more suits and had to pay for more labor, making that his inventory cost. By the end of the year, John still had $7,000 worth in stock, making that his ending inventory. Based on these numbers, John’s cost of goods sold would be as follows:
$50,000 + $15,000 – $7,000 = $58,000
It is possible to find a cost of goods sold calculator online to help with the calculations.
