As a business owner, accurately understanding the cost of goods soldis an essential element of effective financial management.
By understanding your cost of goods sold (COGS), you can make informed decisions and identify opportunities to improve your company's success.
In this blog post, Viindoowill delve into what COGS is, highlight its importance, and give you insight into how COGS is calculated.
What is Cost of Goods Sold (COGS)?
Cost of goods sold (COGS) includes all costs related to the production of products that are consumed during an accounting period. This includes costs from purchasing raw materials to the finished product. Cost of sales is an important indicator in financial reports, directly affecting the profit of the business. Therefore, managers need to accurately calculate the cost of sales to make appropriate business decisions.
What is the cost of goods sold (COGS)?
Depending on the type of business, each business will have its own classification cost of goods sold different:
- The cost of materials directly: Includes costs directly related to product production. These include raw materials, input materials, packaging materials,...
- Direct labor costs: Includes salaries, wages, and allowances of employees directly involved in product production.
- General production costs: These are costs related to the production process but cannot be directly assigned to each specific product. These include depreciation costs, maintenance of machinery, equipment, electricity, water,...
- Purchase costs: Includes costs related to the purchase of sold goods and services, such as purchasing costs, transportation, loading and unloading costs,...
In particular, direct material costs and direct labor costs are two main components of cost of goods sold. Manufacturing overhead and purchasing costs can be allocated to each specific product or in a certain proportion.
Why do businesses need to pay attention to how to calculate the cost of goods sold?
Below are the reasons that businesses need to pay attention to how to calculate cost of goods sold:
- Product Pricing: Cost of goods sold is an important factor in determining the cost of your products. If you don't know your cost of goods sold, you can set the price too low, resulting in lower profits, or too high (expensive), resulting in decreased sales.
- Inventory management: Cost of goods sold also plays an important role in your inventory management. By understanding your cost of goods sold, you can determine the optimal inventory level to maintain, preventing overstocking of inventory shortages.
- Financial analysis: Cost of goods sold is an important measure to analyze the financial situation of your business. It allows you to compare costs with revenue and identify areas where you can cut costs or drive efficiency gains.
Cost of goods sold directly affects corporate finances
How to calculate cost of goods sold
For retailers, the formula to calculate cost of goods sold is:
Cost of goods sold = Beginning inventory + Purchases during the period - Ending inventory
To better understand this formula, let's break it down into its components:
- Beginning inventory: Includes all the products you had in stock at the beginning of the accounting period.
- Purchases: Includes the cost of all inventory purchased during the accounting period, including raw materials, labor, and other direct costs.
- Ending inventory: This is the value of your inventory at the end of the accounting period.
After calculating cost of goods sold, you can use this information to determine gross profit by subtraction cost of goods sold from its total sales revenue.
For retailers, calculating cost of goods sold is relatively simple
Standard accounting methods to calculate COGS
FIFO method - First in, first out
FIFO (First In, First Out) is a method of calculating cost of sales based on the principle of first in, first out. Accordingly, the cost price is calculated based on the price of the first imported shipment with the corresponding quantity. If the first shipment is insufficient to satisfy, the price of the next shipment will be used. The FIFO method ensures that inventory is sold in the order in which it is received, thereby accurately reflecting inventory value and Cost of goods sold Order Time.
The calculation formula is as follows:
Cost of goods sold = Price of products and goods first warehoused
Calculating according to the FIFO method is calculating the cost of goods sold based on the principle of first in, first out
Illustrative example: A production and business enterprise has:
- Inventory at the beginning of the period: 100 products at a price of 100,000 VND/product.
- First warehouse entry: 50 products at 120,000 VND/product.
- Second warehouse entry: 150 products at 90,000 VND/product.
Cost of goods sold of 150 products sold is determined by the following formula: (100,000 x 100) + (120,000 x 50) = 16,000,000 VND.
LIFO method - Last in, first out
LIFO (Last In, First Out) is a cost of goods sold method according to the principle of last in, first out. According to this method, the cost price is calculated based on the price of the most recently imported goods. If the most recent shipment is not sufficient, the price of the previous shipment will be used. The LIFO method ensures that inventory is sold in the reverse order from the order in which it was received, thereby accurately reflecting the actual value of inventory at the end of the period.
The calculation formula is as follows:
Cost of goods sold = Price of final warehoused products and goods
Calculating according to the LIFO method is calculating the cost of goods sold according to the principle of last in, first out
Illustrative example: A manufacturing and trading enterprise has:
- First warehouse entry: with 20 products with unit price of 100,000 VND/product.
- Second warehouse entry: 25 more products with unit price of 110,000 VND/product.
- After that, the company sold 30 products
- Applying the LIFO method, the cost of goods sold of 30 warehoused products is calculated as follows: (20 x 100,000) + (10 x 110,000) = 3,100,000 VND.
Weighted average method
According to the weighted average method, the value of each type of inventory is calculated according to the average value of each similar type of inventory at the beginning of the period and the value of each type of inventory purchased or produced during the period. Currently, this is a very popular method and is applied by many large and small businesses.
The calculation formula is as follows:
Average cost of goods sold = (Total value of inventory before import + Total value of inventory when newly imported)/Total amount of inventory before and after import
The weighted average method is a way to calculate the cost of goods sold based on the ratio between the total value of warehousing and the total inventory before and after import
Illustrative example: A production and business enterprise has:
- Inventory at the beginning of the period: 100 products at a price of 100,000 VND/product.
- First warehouse entry: 50 products at 120,000 VND/product.
- Ending inventory: 150 products.
We have:
1. The average price of inventory is determined as follows: (100 x 100,000 + 50 x 120,000) / (100 + 50) = 108,000 VND/product
2. Cost of goods sold for 150 products sold: 108,000 x 150 = 16,200,000 VND.
Amounts excluded from cost of goods sold
Although the cost of goods sold includes most of the direct costs associated with the products being manufactured and sold, there are still some exclusions that businesses need to be aware of. Include:
- Indirect costs: Indirect costs, such as rent, utilities, and administrative costs are not included in the cost of goods sold. These costs are recorded separately on the income statement.
- Marketing and advertising costs: Costs related to marketing and advertising are not included in the cost of goods sold. These costs are considered selling expenses and are also recorded separately on the income statement.
- Research and development costs: Any costs related to research and development are not included in the cost of goods sold. These costs are considered part of the company's operating expenses.
Cost of goods sold includes many costs
How to show COGS on the income statement
COGS is reported on the income statement as a separate line item below the revenue section. It is typically listed as the first expense item and is deducted from the total sales revenue to determine the gross profit. Here's an example of how COGS is reported on an income statement:
|
+ Revenue from contracts with customers
| $100,000 |
|
- Deductions
| $2,000 |
| = Revenue | $98,000 |
- Cost of Goods Sold | $48,000 |
= Gross profit | $50,000 |
This is important to note Cost of goods sold is only one component of the income statement and does not include all of the costs associated with running a business. Other costs, such as operating expenses and taxes, are also included in the income statement.
Calculating cost of goods sold is simpler using Viindoo Payroll software
Above, we have learned the principles of determining the cost of goods sold. Next, we will explore how Viindoo software calculates the cost of goods sold using the FIFO inventory valuation method and the perpetual Inventory system (automatic).
Configure product catalogs in one setup step
Users need to set up as shown in the image below and they are done.
Set up product groups in one step
For each product, Viindoo is established to be associated with a certain product group. That allows you to set up just once for multiple products with similar properties, types, and warehouse management methods.
Configuration of Products
Make Sales
When you make a sale products, Viindoo will automatically calculate the cost of goods sold (COGS) using the FIFO method.
Create sale order products with the FIFO inventory costing method Viindoo
Manage your inventory - As you purchase new inventory items and sell existing ones, Viindoo software will automatically track all of your inventory movements, costs, and quantities. This ensures that your COGS and ending inventory values are always accurate based on the FIFO method.
Inventory report in Viindoo
>>>> Note: For manufacturing companies, the cost of goods manufactured is calculated by dividing the cost of goods manufactured by the total number of goods produced, multiplied by the number of goods sold in the warehouse. We have a separate article on Manufactured Product Costs - this is a very complex issue. See more details in the article: Cost of goods manufactured.
Accounting and Reporting
Viindoo software application calculating the cost of goods sold not only helps businesses calculate the cost of goods sold automatically with just simple settings, but also allows for automatic recording of arising accounting facts. From there, data is always available to prepare reports: inventory reports, inventory valuation reports, profit and loss reports, etc.
Inventory report in Viindoo
P&L report in Viindoo: COGS
With general management software like Viindoo, all worries about manual operations, manual accounting, delayed and non-instant reports have been eliminated. Now, businesses can completely optimize their finances and develop their business with wise and timely decisions. Businesses can fully automate management, accounting, and collaborative work with the Viindoo ecosystem: accounting software, purchasing software, sales software, warehouse software etc., and a variety of built-in features. See more at: Viindoo's overall business management solution.
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Cost of Goods Sold (COGS) refers to the direct costs incurred by a company in the production and sale of its products. It includes the expenses related to materials, labor, and overhead directly associated with manufacturing. COGS is important for businesses because it directly impacts the company's profitability. By accurately calculating COGS, businesses can determine the true cost of their products, make informed pricing decisions, manage inventory effectively, and assess their overall financial health.
There are two main methods for calculating COGS: the periodic inventory method and the perpetual inventory method.
Beginning Inventory + Purchases - Ending Inventory = COGS
Beginning Inventory represents the value of the products in stock at the beginning of the accounting period. Purchases include the cost of all inventory purchased during the period, including raw materials, labor, and other direct expenses. Ending Inventory represents the value of the remaining inventory at the end of the period. By subtracting the ending inventory value from the sum of beginning inventory and purchases, businesses can determine their COGS.
Beginning Inventory + Purchases + Direct Labor + Manufacturing Overhead - Ending Inventory = COGS
In addition to beginning inventory, purchases, and ending inventory, manufacturers also consider direct labor costs and manufacturing overhead. Direct labor includes wages and benefits paid to employees directly involved in the production process, while manufacturing overhead encompasses indirect costs such as rent, utilities, and equipment maintenance. By subtracting the ending inventory value from the sum of all these components, manufacturers can determine their COGS.
COGS is reported on the income statement as a separate line item below the revenue section. It is typically listed as the first expense item and is deducted from total sales revenue to determine the gross profit. Other expenses, such as operating expenses and taxes, are also included in the income statement. COGS provides insight into the direct costs associated with the production and sale of products, while operating expenses capture the indirect costs of running the business.
Conclusion
In conclusion, understanding and accurately calculating cost of goods sold (COGS) is crucial for businesses of all sizes. It allows you to determine the true cost of your products, make informed decisions, and improve your business's profitability. For a simplified and efficient COGS calculation process, consider using Viindoo, a comprehensive business management software that includes COGS tracking and analysis features. With Viindoo, you can streamline your financial management and take your business to new heights.
