Every business needs to have a good understanding of the Cost of Goods Sold (COGS). This very vital to the growth of any business. It’s not just a figure you need to fill in your tax return. Instead, it helps you make better business decisions.
From production to delivery, it is a good practice to keep accurate records of every expense incurred for a product. A summation of these costs subtracted from your revenue tells you your profit.
Here, we will explore some of the things you need to know about COGS as related to a small business.
What is the Cost of Goods Sold?
Cost of Goods, sometimes also called Cost of Sales or Cost of Revenue, is the total cost of producing and delivering a product.
Whether the product is acquired and resold or produced from scratch, the COGS covers all the expenses involved in getting it done. It includes the costs of production materials, costs incurred in the production process, and the cost of delivery.
However, indirect expenses do not count for COGS. Fixed costs such as staff salary, rent, and the likes are not affected by momentary sales and are not covered in COGS.
If you are still not sure whether or not an expense is part of your COGS, ask yourself these quick questions:
“Will I still incur this cost if I don’t sell this product? And does this cost change with variation in sales.
If your answer is affirmative, then the cost should be included in your COGS, and vice versa.
Why is COGS Important For A Small Business
Knowing your COGS helps you decide the perfect pricing for your products and services. You will choose prices big enough to cover all your expenses and moderate enough not to scare away customers.
COGS is tax-deductible. By getting an accurate record, you can be sure no cost is left out. This increases your tax-free income, and that means a greater profit.
It gives you a better view of the financial health of your business. With that, you can make better decisions for business growth.
How to Calculate COGS?
Getting to know the exact figures of your COGS over some time requires that you get the following information.
- The total inventory value at the beginning of the period.
- The total cost of inventory was purchased within this period. You can also add other direct costs such as direct labor, delivery fee, facility expenses, etc if there are any.
- The total value of inventory at the end of the given period.
The simple formula for calculating COGS is:
COGS = (Starting Inventory + Inventory Purchased + Other Direct Costs) – Ending Inventory.
How to Reduce COGS?
Minimizing the COGS sure has some positive effects on the profit level of the business. Here are some steps you can take to reduce the COGS.
- Seek possible discounts by purchasing in bulk.
- Check out alternative suppliers for the best deals.
- Maximize less expensive materials where possible.
For the growth of your small business, you need to find efficient ways to manage costs and maximize profits.
Calculating your COGS will give you a better understanding of where your resources are going into and how best to improve operations.