If you're a business owner (or anyone who’s been within touching distance of an accountant), you'll have heard of COGS. It sounds like something that might help your enterprise run smoothly, and it is. COGS stands for one of the small trader’s most valuable tools: Cost of Goods Sold. A recent study by Regus showed that 83 per cent of you expect your manufacturing budget to stay the same or be cut. So here's a guide to what COGS covers, and how it could help you save some precious pennies.
Profits are never that simple
A common mistake for those new to retail is to take the retail price, subtract the wholesale cost and drool at the massive profits they’re sure to make. But you need to use COGS to show what it costs to make those products in the first place.
What to include in COGS
COGS considers all expenses needed to produce goods – not just raw materials but direct labour too. For example, if you're supplying cafés with a new superfood smoothie, your COGS includes the wholesale cost of the fruit, plus the energy it takes to blend it, your team's wages and the cost of the bottles and labels.
What to leave out
Renting a warehouse, fuelling and maintaining a delivery van and financing ads for your delicious drinks are not part of COGS – they're indirect expenses. So are admin costs, like the fee you've charged your accountant to explain what COGS is.
Where’s the money going?
Separating costs into direct expenses (COGS) and indirect expenses shows you exactly where the money is going in your business, and where you can make adjustments to boost your net income.
Bringing inventory into the equation
In any given accounting year, your business probably won't sell all its products and start the next year at zero. This is where your inventory comes in. At the beginning of the year, our smoothie maker works out the value of any unsold products (her inventory).
She adds this value to the direct cost of producing more smoothies for the year ahead. At the end of the year she subtracts the value of any remaining smoothies to find her COGS.
By including inventory values from the beginning and end of the year, COGS shows our smoothie-maker not just how much it costs to produce a bottle of luscious juice, but how much her business is spending on the bottles she has actually sold.
And that can make a difference between the success and failure of her outfit – and yours too.
Is it worth it? Calculating the cost of each sale
