Because distribution costs are overhead and not COGS, they are a part of operating expenses (OPEX).
Understanding what the cost of goods sold includes is a crucial part of budgeting, planning, and financial forecasting for small businesses.
Profit Frog simplifies COGS and operating expenses. Our financial planning software helps small businesses track expenses, profit, and other key business drivers, and allows them to forecast into the future.
What Is A Distribution Cost?
Distribution costs are expenses that a business incurs to make its services or goods available to customers. For a manufacturing business, distribution costs will include all expenses incurred for product delivery.
Distribution costs are considered to be a part of SG&A.
What are SG&A costs?
Selling, general and administrative, also known as SG&A, is a category of expenses that are not directly related to manufacturing goods or delivering services.
SG&A are not cost of goods sold (COGS) expenses because they are not directly implicated in manufacturing a product or delivering a service. They are fixed costs and part of the business overhead. As with other types of costs, business owners want to minimize SG&A to increase profitability.
What is Included in Distribution Costs?
In order to deliver goods or services to a customer’s location, the manufacturer incurs costs such as following:
- Freight costs
- Storage costs
- Product handling costs
- Managerial personnel costs
How To Calculate Distribution Costs?
The following formula is traditionally used to calculate company’s distribution costs:
Distribution Costs = Total Purchase Price – Fair Value of Net Assets
The traditional distribution costs formula is backward-looking, deriving distribution costs from the fair value of net assets. This means waiting until an accounting period (whether a month, a quarter, or a year) is closed to have visibility into distribution costs. We prefer a real-time approach.
Real-Time Cost Calculations
By deferring distribution cost calculations until after the books are closed on an accounting period, many business owners make a crucial, sometimes fatal mistake: they don’t have a real grasp on their indirect costs. Hence, they don’t know where to focus their cost-reduction efforts.
Instead of struggling with backwards-looking calculating methods, Profit Frog offers real-time visibility into a company’s finances.
Business owners plug in expenditures regularly, and our software helps code them correctly. With Profit Frog, you have up-to-date visibility into distribution costs, fixed vs variable costs, COGS, SG&A, OPEX, profitability, and all the other metrics that matter.
What is COGS?
Cost of goods sold, COGS, measures those costs associated with producing a good or delivering a service.
Generally accepted accounting principles (GAAP) COGS definition: the overall cost of manufacturing the items sold during a selected period. Along with revenue, cost of goods sold will appear on income statements.
Our cost of goods sold definition: all direct costs involved in manufacturing a product or delivering a service.
Cost of Goods Sold for SaaS Businesses
Since SaaS businesses provide their customers with software instead of manufacturing goods, calculating COGS is quite different. Because SaaS companies have no “goods sold” most business owners will refer to this metric as cost of sales or cost of revenue.
Understanding SaaS COGS and OPEX is important for correct accounting and modeling. Our SaaS business forecasting software includes a COGS calculator to make COGS—and all other aspects of budgeting and forecasting—much easier.
Cost of Goods Sold for Manufacturing Businesses
COGS, sometimes referred to as cost of sales, measures the direct costs of producing goods for a manufacturer.
Cost of goods sold includes all costs associated with manufacturing. For example, if a company is selling a physical product, the cost of goods sold will include transportation costs, direct material costs, and any other direct expenses.
The COGS figure consists mostly of variable costs. Some companies consider the cost of goods to include all of their variable expenses, and put all fixed costs under overhead costs (operating expenses).
Cost of Goods Sold for Service Businesses
If you own a service business (for example a locksmith company), COGS will include business expenses involved in providing the service: direct labor, tools, and parts used, and transportation costs.
What Is Included in the Cost of Goods Sold?
COGS includes all costs of developing (manufacturing) a product or delivering a service. For instance, if your business makes and sells a physical product, the cost of goods sold will include transportation costs, factory labor costs, raw materials purchases, and other direct expenses.
Businesses that sell and manufacture products should have these variable costs as part of their COGS:
- Raw materials
- Storage costs
- Transport costs
- Tools and parts used during the production
- Direct labor
There’s the traditional, backwards-looking way of calculating the cost of goods sold. Then there’s the real-time, Profit Frog way.
Traditional Cost Of Goods Formula
The traditional, inventory-based cost of goods sold formula retrospectively calculates COGS after an accounting period has closed. This doesn’t give much actionable insight to the entrepreneur trying to make real-time decisions.
COGS = Beginning Inventory + Purchases during the period – Ending Inventory
- Beginning inventory: a business’s inventory at the beginning of an accounting period.
- Purchases: the cost incurred to produce a good or service during an accounting period.
- Ending inventory: the inventory remaining at the end of an accounting period.
All inventory that is sold will be shown as sales. The items that didn’t get sold in the previous year become part of the beginning inventory for the upcoming year. If the business makes or purchases additional products, they will be added to the inventory.
There’s a better way to track COGS (and OPEX too, for that matter).
Calculating COGS with Profit Frog
Profit Frog takes a real-time approach to COGS. Business owners plug in all their costs, including COGS, into their dashboard and see a current snapshot of their business’s health.
No waiting until the end of an accounting period: they have up-to-the-moment visibility into the real drivers of their business. Then, they can forecast COGS, OPEX, profit margins, and more into the future by manipulating variables and creating different scenarios. This is known as scenario planning and it helps our customers stay ahead of the curve.
With Profit Frog, business owners don’t need to stress about calculating costs. Just follow our prompts and see how stress-free budgeting and forecasting can be.
We give you a clear view of what’s going on in your business and where you can increase profitability.
Frequently Asked Questions About COGS
Is cost of goods sold a fixed or variable cost?
While it can include both fixed and variable costs, COGS is mostly variable costs. Some accountants consider the cost of goods sold to be exclusively variable expenses, putting any fixed expenses under OPEX.
Most common fixed costs included in COGS are equipment depreciation costs and salaries for personnel responsible for product quality.
Together, variable and fixed costs make up the total expenses of running a business.
An administrative cost is commonly mistaken for a variable cost; it is a fixed cost, and a part of operating expenses (OPEX).
What is the difference between operating expenses and SG&A?
Selling, general and administrative expenses include all costs that are non-production. SG&A is often used as a synonym for OPEX, yet they are sometimes shown as separate line items on income statements. Like OPEX, SG&A expenses are associated with overhead, as they can’t be directly tied to production.
In contrast, COGS and SG&A are opposite of one another. Cost of goods sold is directly tied to production, while SG&A is not.
Is COGS an asset?
COGS is not an asset. It is an expense. Expenses are the cost of running a business; they are one of five main accounts in bookkeeping.
Cost of goods sold is an expense account on an income statement, making it a debit. Since COGS is a debit, not an asset, it is a business factor that should be minimized.
Are there any exclusions from COGS?
Inventory-based COGS accounting systems are traditionally used in larger companies. Usually motivated by a desire to impress investors (or potential investors), accountants can manipulate cost of goods sold via any of the following:
- Not writing off obsolete inventory
- Fudging the amount of inventory at the end of an accounting period
- Overstating discounts
- Overstating returns to suppliers
- Valuing end-of-period inventory at more than fair market value
Because the value of inventory can be artificially inflated, the cost of goods sold can be under-reported, which can show inaccurate net income.
Profit Frog customers typically aren’t subject to the same COGS limitations for the following reasons.
- Our average customer is a bootstrapped Main Street business, not a VC-funded startup
- We don’t use backwards-looking inventory valuation systems for calculating COGS; instead, we use a real-time approach that helps you stay ahead of the curve
OPEX vs COGS: what is the difference?
COGS and operating expenses are different categories of costs that companies incur. COGS and OPEX values are recorded as separate items on the income statement. COGS plus OPEX equal total costs.
OPEX includes most overhead costs, including:
- Legal costs
- Insurance costs
- Office supplies
- Interest paid on debt
- Administrative expenses
- Human resource costs
- Any other indirect costs (expense not directly related to revenue generation)
Selling, general, and administrative expenses (SG&A) are included in OPEX. These include most sales force costs, software subscriptions, and other overhead.
Operating expenses and COGS calculations are hard for an average company owner. That is why Proft Frog makes calculating OPEX vs COGS simple and efficient.
Cost accounting and forecasting become easier with Profit Frog.
Where can you find the cost of goods sold on an income statement?
Typically, COGS will be found directly underneath total revenue when you are looking at a business’s income statement. A business income statement is not the same as a balance sheet.
Gross profit is listed below COGS. It is listed there because gross profit is calculated by subtracting COGS from revenue.
Using Profit Frog’s financial modeling software will help you navigate uncertainty and have correct summaries. It will help you understand how modeling your financial profitability will improve your business performance.
What are the accounting methods for COGS?
There are three traditional methods for calculating COGS. All are backward-looking and are based on inventory valuations.
For small businesses, we recommend none of these three accounting methods. Instead, we favor a real-time COGS tracking model.
The three traditional COGS accounting methods are the FIFO method, the LIFO method, and the WAC method. All three are formulas to value your inventory—and to derive COGS from inventory values.
Instead of the above inventory-based accounting methods, Profit Frog offers real-time visibility into a company’s COGS.
By deferring COGS calculations until after the books are closed on an accounting period, many business owners make a crucial, sometimes fatal mistake: they don’t have a real grasp on their cost of goods sold. Hence, they don’t know where to focus their cost reduction efforts.
In addition to modeling costs (COGS and OPEX), Profit Frog allows small businesses to model growth, new market opportunities, and other variables.
Plus, calculating the cost of goods sold is much easier when you use Profit Frog.
How do you calculate gross profit margin?
Gross profit margin is the ratio of gross profit to revenue, expressed as a percentage. Here is the gross profit margin formula: Gross Profit Margin = (Revenue – COGS) / Revenue x 100.
For example, say a seamstress made a dress for $50. Assuming the dress costs $15 to make, the seamstress has a gross profit of $35. In this example, the seamstress would have a gross profit margin of 70%.
- Total product revenue: $50
- Total cost of production: $15
- Gross profit: 50-15 = $35
- Gross profit margin: 35/50 x 100 = 70%
A company’s gross profit margin indicates how successful it is at generating revenue while keeping COGS low.
Our profit modeling software shows your gross profit margin, and every other type of profitability calculation you could ever need.
Is marketing included in COGS?
Marketing is not included in COGS. Because marketing is an indirect expense, it isn’t involved in producing goods or delivering services; it is part of operating expenses (OPEX).
About Profit Frog
Profit Frog is the leading budgeting and forecasting software specifically designed to eliminate complexity for small businesses. Where other FP&A software solutions focus on complex forecasting of cash flow and other factors, Profit Frog strips forecasting down to the thing that matters most: profitability. Our profitability modeling tools allow you to assess the health of your business quickly, and look into the future to understand how all of your variables will affect future profitability as you adjust them. Armed with this knowledge, you can chart a path to maximum profit.