What is the cost of goods sold?
The Cost of Goods Sold(COGS), also known as the cost of sales, refers to the direct cost of producing a product from principles to conception to when the company is ready for sale. It is simply the cost of every item that a company manufactures and sells. The sum of cost includes expenses of the materials and labor used directly to create a product.
In traditional manufacturing, the cost of goods sold covers expenses such as inventory. At the same time, in the development world, particularly SaaS, the COGS includes hosting and monitoring charges, account management, license fees, professional services, and support costs.
What Is Included In Cost Of Goods Sold
COGS covers all direct expenses incurred to create the products a company offers. Most of these are variable costs, i.e., materials and labor, while the rest can be fixed costs, such as factory overhead. The best way for companies to determine what to include in the COGS is to ask themselves if the cost would exist if the business had never developed the product. If the answer is no, you should include the expense in COGS. In this regard, here are some expenses considered COGS:
● Raw materials for the product development manager
● Freight-in costs
● Purchase returns and allowances
● Trade or cash discounts
● Factory labor
● Storage costs
● Factory overhead
Exclusions From the COGS
The Cost Of Goods Sold does not include general, selling, or administrative costs, i.e., office rent, distribution costs, advertising, legal fees, and salaries. Also excluded from COGS is the cost for unsold products at the end of a given period. Instead, these are recorded in the inventory at the period’s end.
What Is the Purpose of COGS
The cost of goods sold is simply the expense of doing business. Therefore, it plays a significant role in how any production company operates. For instance, to determine a company’s profit margin and how lucrative and scalable an organization is, analysts, investors, and managers have to calculate the cost of goods sold (COGS). This is because a company’s net income decreases with increased COGS so that the business will have fewer profits for its stakeholders.
How To Calculate The Cost Of Goods Sold
On the surface, calculating the COGS is simple and comprises three variables, i.e., beginning inventory, purchases, and ending inventory. However, each component contains complex layers that require several steps to calculate. They include:
- Identifying the beginning inventory of the materials required to manufacture the product, then work in process and finished goods based on the prior year’s ending inventory amounts.
- Determine the cost of raw materials that you purchased during the development period. These include labor fees, shipping charges, overhead expenses such as power or office space, subscriptions, licensing, hosting, and other professional services you have paid for in the past year.
- Determine the ending inventory balance. To get the cost of goods sold for your final product, you must first deduct any costs associated with materials or inventories that are still in use at the end of the year. Then ensure that any other direct costs incurred during production are included in the inventory valuation.
