There are a lot of metrics small business owners must watch, some of which are obvious while others are not-so-obvious. One of the lesser-known metrics is cost of goods sold (COGS). As the name suggests, this is to the total cost of the merchandise that a company has sold. COGS can be calculated by the retailer, product manufacturer or product distributor.
So, what’s the purpose of keeping track of COGS? Aside from the fact that it’s a good accounting practice, doing so will prove useful come tax time. This is because COGS is reported as a business-related expense for the associated accounting period. Small business owners must match the COGS with the revenue produced from the sold goods to achieve the matching principle of accounting. Therefore, the total sales revenue minus the COGS equals the gross profit.
There are a couple different ways to calculate COGS, one of which is to adjust the total cost of goods purchased or manufactured by the difference in inventory of the final products. If 500 product units were purchased but your inventory increased by 50, then the cost of 450 product units would be your COGS. Here’s another example: if 2000 product units were purchased and your inventory increased by 1000, then the cost of 1000 units would be your COGS. Following this formula is actually pretty simple and straightforward, which is why many small business owners and professional accountants prefer it.
If that method sounds too confusing, however, there’s an alternative technique used to calculate the COGS. It involves adding your starting product inventory to the total cost of goods purchased or manufactured, and then subtracting this amount by your ending inventory.
Being a small business owners requires you to keep track of lots of metrics, which can prove tedious and daunting to some. Once you learn the ropes of metrics like gross revenue, net revenue and COGS, however, things become a little easier. This post should give you a better understanding of how to calculate COGS for your respective business. Regardless of what type of business you operate, calculating COGS remains roughly the same. Just use one of the two methods listed here and you’ll be well on your way to calculating the COGS.