# How to Calculate Cost of Goods Sold (COGS)

Are you looking to start your own business? There are dozens of areas that you’ll need to be well-versed in if you hope to take on the task of becoming your own boss. Among the several soft skills you’ll need to master, you’ll also need to learn how to calculate your finances. Chief among these is learning how to calculate the cost of goods sold (also known as COGS.)

## What Does Cost of Goods Sold Mean?

Cost of goods sold (COGS) is an essential financial statement statistic since it is deducted from a company's revenues to determine gross profit. Gross profit is a profitability metric that assesses how well a business manages its personnel and materials during the manufacturing process.

Analysts, investors, and managers can predict the company's bottom line by knowing the price of products sold. By learning the cost of goods sold formula, you're essentially breaking down the cost of doing business. To this end, companies must continually calculate cost of goods sold and keep COGS low to increase net profits since net income will drop as COGS rises.

## What is Included in the Cost of Goods Sold?

The cost of goods sold equation includes following items:

• Cost of products that will be resold
• The price of raw materials
• Parts utilized to manufacture a product
• Materials used in the production or sale of the product
• Costs of direct labor
• Distribution and sales force costs
• Utilities at the industrial site
• Costs of containers
• Costs of shipping or freight

Keep in mind, whether direct or indirect, expenditures paid on products that the company did not sell throughout the year will not be included when computing COGS. At its core, the COGS calculation comprises the direct costs of manufacturing products or services that consumers purchased during the year.

## Why is the Cost of Goods Important?

The primary motivation for beginning a business is to make money. Even if the endeavor is for altruistic reasons, only when a businessperson understands their exact costs and earnings from selling their items can they make a profit and continue offering their services.

Understanding how to find cost of goods sold offers an entrepreneur an estimate of how much it will cost them to procure the material they want to sell. As a result, it forms a significant component of their financial picture.

Here are some financial incentives for understanding how to calculate cost of goods sold.

### Assists in the development of a pricing strategy

You can determine your selling price by calculating the entire cost of the goods you purchased. You will be better positioned to identify the price at which you would want to sell the goods once you know the amount you paid for them. As a result, knowing COGS may help you figure out how much profit margin you can maintain on the items you sell.

### Assists in establishing the actual costs of acquiring the items

All of your expenses and revenues must be listed on your balance sheet. So, after you know how much you paid to get the items to market, you may calculate real expenses by adding extra overhead costs, such as sales and marketing.

### Allows you to compare your product's market worth to that of your competitors

If your prices are lower than your competitors', you will lose money since you have a low-profit margin. As a result, learning how to calculate COGS indirectly assists you in selling your goods at the correct price, resulting in increased sales and profit.

Now that you understand the necessity of calculating COGS, let's look at how to do it with a formula.

## The COGS Formula

The COGS formula is a relatively simple calculation:

Your COGS calculation = Starting inventory + purchases - ending inventory

• Starting inventory are the products left over from the previous period (e.g., month, quarter, etc.)
• Purchases account for the price of what you bought during the accounting period.
• Ending inventory are the products that you didn't sell within the time frame.

Depending on your business and goals, COGS can be calculated weekly, monthly, quarterly, or yearly.

## Cost of Goods Sold Example

To give a concise example of how to calculate cost of goods sold, we’ll assume that Company XYZ Inc. has the following inventory data for the calendar year ending on December 31st, 2020.

• Starting Inventory = \$10,000
• Purchases = \$5,000
• Ending Inventory = \$2,000

The initial inventory at the start of the year (January 1st, 2020), is \$10,000, and the ending inventory on December 31st, 2020, is \$2,000. Throughout the year, the company makes purchases of \$5,000.

With the above information, the cost of goods sold formula would look like this:

• COGS = \$10,000 + \$5,000 – \$2,000
• Resulting in a Cost of Goods Sold of \$13,000

## Take Your Accounting to the Next Level

If you want a more thorough understanding of how to calculate cost of goods sold and what it can do for your business, contact the Business Consulting Group at Porte Brown. We help our customers understand their financial data to improve efficiency, uncover hidden possibilities, and get a more substantial insight into their long-term worth.

Enjoy this piece of content and want to learn more from one of the top accounting firms in Chicago? Porte Brown's blog is just what you need. Click here to explore today!