Here’s how to calculate the cost of goods sold—but if you use Profit Frog, you don’t need to worry about the rest of this article. We do COGS calculations for you.
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Profit Frog is the leading financial planning and analysis (FP&A) software specifically for small businesses. We simplify COGS calculations and make them actionable so you can improve profitability.
What Is COGS?
Cost of goods sold (COGS), sometimes termed cost of sales, measures those costs associated with delivering a service or producing a good, including raw materials and direct labor. For a manufacturing company, any direct manufacturing cost would be COGS.
According to generally accepted accounting principles, COGS is the overall cost of producing the items sold during a selected period. Along with revenue, cost of goods sold will appear on a company’s income statement.
Our COGS definition: all direct costs involved in manufacturing a product or delivering a service. We like this cost of goods sold definition because it includes service businesses.
COGS is a key component when calculating two crucial financial metrics:
- Gross profit
- Gross profit margin
Gross profit is calculated by subtracting COGS from revenue. Gross margin is calculated by dividing gross profit by total revenue, and multiplying the resultant number by 100.
Gross margin calculation: (gross profit / revenue) * 100
What Accounting Method for COGS is Best?
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.
Three Traditional COGS Accounting Methods
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.
- First in, first out (FIFO). The earliest goods that get manufactured or purchased are sold first. Because prices tend to go up over time, businesses using the FIFO method sell their least expensive products first. This translates to lower COGS under FIFO; which is why net profit while using FIFO may increase over time.
- Last in, first out (LIFO). The LIFO method mandates that the latest inventory gets sold first. Costs usually increase over time, leading to later inventory having a higher cost basis than earlier inventory. This dynamic can lead to higher COGS, bringing net income down over time.
- Weighted average cost (WAC), sometimes termed average cost method. Regardless of the purchase date, the average price of all inventory is used as a cost basis for each individual product sold. By averaging prices throughout the period, the averaging method smooths out price fluctuations, making the calculation more simple and straightforward.
Let’s look at why there’s a better way for small businesses to keep tabs on expenses.
Actionable Expense Tracking
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.
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What Is The Best Cogs Calculator?
Profit Frog helps you analyze and collect data for cases like seeing future or current products. Understanding OPEX and COGS is crucial when planning for your small business. We have a COGS calculator that provides you with a clear picture of your expenses, helping you build the business you strive for.
Profit Frog helps you compute cost of goods sold by having you put in the costs of the following, one by one:
- Direct materials
- Direct labor costs
- Shipping costs
- Waste
- Other direct costs
A process like this will help you have a clear understanding of what goes into producing every product or service. Ultimately, this will lead to having a better understanding of your business and where your profit centers lie.
Our COGS calculator will allow you to dynamically model different costs, and use them to forecast possible futures. Scenario planning forecasts and profitability models will allow you to make plans adjusted as conditions change.
By embracing dynamic planning, you will be able to stop guessing and break free from stagnant business plans that don’t work.
Cost of Goods Sold Formula
Finding the right cost of goods sold formula can be hard, even with numerous online calculators and guides for small businesses.
COGS = Beginning Inventory + Purchases during the period – Ending Inventory
- Beginning inventory: a business’s inventory at the beginning of an accounting period.
- Purchases: costs incurred to produce a good or service during an accounting period.
- Ending inventory: the inventory remaining at the end of an accounting period.
Let’s say your business had a beginning inventory value of $14,000. There are also $5,000 of costs (purchases), and you have $3,000 inventory remaining; that gives a COGS of $16,000 for the accounting period.
COGS= $14,000+ $5,000 -$3,000 = $16,000
Business owners don’t need to worry about the COGS formula, the right inventory costing method, or other minutiae when using Profit Frog. Our intuitive software guides you to enter your different expenses and categorizes them appropriately.
With Profit Frog, there is no need for business owners to worry about calculating costs, finding the COGS formula, or trying to calculate OPEX. Simply follow our prompts and see how easy budgeting and forecasting for small businesses can be.
We give you a clear view of your company’s cost of goods sold and show you how you can increase profitability.
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Operating Expenses vs. COGS
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.
Operating expenses (sometimes termed operational costs) and COGS are mutually exclusive. If an expense is COGS it is not OPEX, and vice versa.
OPEX includes:
- Rent
- Utilities
- Legal costs
- Insurance costs
- Office supplies
- Interest paid on debt
- Administrative expenses
- Human resource costs
- Any other indirect cost (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 vs COGS calculations are difficult and confusing for the average owner of a small business. Profit Frog makes calculating COGS vs operating expenses easy and efficient.
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What Are Variable Costs?
Variable costs are corporate expenses that change in proportion to how much your business sells or produces. Depending on your company’s sales value or production, variable costs will increase or decrease—they fall as the production decreases and rise as production increases.
The majority of COGS are variable costs as they include direct labor costs and material inputs.
Variable costs can include:
- Raw materials: these are purchased and used for creating the final product.
- Direct labor: workforce inputs that contribute directly to producing a product or delivering a service.
- Commissions: a percentage of sales that is awarded to salespeople as performance-based compensation. If there are no sales, there will be no commission expenses; higher sales bring higher commission payouts.
- Utilities: a business may consume more electricity, water, and other resources if production increases.
- Shipping: transportation and shipping costs are usually fairly constant on a per-product basis, but total shipping expenses increase with the quantity of product shipped. Thus, increased output brings increased transportation cost.
Calculating total variable costs is simple. The quantity of output is multiplied by the variable cost per unit of output.
Total Variable Cost = Total Quantity of Output X Variable Cost Per Unit of Output
You can then forecast future scenarios by manipulating all of your business variable costs. This is known as scenario planning, and it helps you navigate uncertainty and guide your company toward success.
Cost of Goods Sold Frequently Asked Questions
What is the cost of goods sold on an income statement?
In most cases, cost of goods sold (COGS) will be found directly underneath the total revenue when you are looking at an income statement. Gross profit will be listed below because it is calculated by subtracting COGS from the revenue. These numbers will give you a clear view of how your business is doing.
Profit Frog’s profitability modeling software will simplify budgeting and help track COGS and other expenses effortlessly. Having a clear picture of key business drivers will help you make strategic decisions and optimize the profitability of your company.
How is COGS classified in financial statements?
When looking at a financial statement, COGS is a business expense. That is because it is one of the costs of generating revenue and doing business.
The cost of goods sold is the direct cost of producing a good which will include direct labor costs and materials used. COGS is an important profitability factor; business owners should make every effort to reduce cost of goods sold while increasing profit.
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 is included in the cost of goods sold?
COGS includes all the costs of manufacturing or developing a product.
If a business is selling a physical product, the cost of goods sold will include transportation costs, the value of your inventory, direct material costs, and any other direct expenses.
A business that manufactures or sells products needs to have these fixed and variable costs incorporated:
- Raw materials
- Storage cost
- Transport costs
- Tools and parts used during the production
- Cost of labor (direct)
Although accounts receivable and inventory are accounts that an owner will report on the balance sheet, only some expenses on the income statements will involve these items. The cost of goods sold on your income statement will report the small small business inventory cost during an accounting period.
How to calculate profit margin?
Profit margin is calculated by first calculating net profit, and then dividing net profit by total revenue (after which you times the answer by one hundred).
To arrive at net profit, subtract all expenses (COGS, OPEX, and any other costs) from revenue.
If you want an easy way to track all these metrics, just use Profit Frog. Not only do we provide clear visibility in to profitability and profit margin, we also allow you to forecast your future profitability and profit margin across different scenarios.
Further Reading on Small Business Finances
Understanding Profit and Loss vs Cash Flow
Making Sense of Your P&L Statement
Advantages and Disadvantages of Scenario Planning
What are the Best Scenario Planning Tools?
Understanding Revenue vs Profit
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 flows and other factors suitable to private equity forecasting, Profit Frog strips small business financial modeling 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. Also, for small businesses struggling to grasp the calculation of cost of goods sold, Profit Frog simplifies the process.
