Profit Frog simplifies calculating profitability, cost of goods sold and operating expenses. We are financial planning and analysis (FP&A) software created specifically to serve small businesses.
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).
What Is The Cost Of Goods Sold?
The cost of goods sold, COGS, is sometimes referred to as the cost of revenue. COGS are the direct costs associated with producing a product or providing a service. Usually, they will include direct labor and raw materials.
Generally accepted accounting principles (GAAP) describes COGS as the general cost of producing items sold during a set period. Aside from revenue, COGS also shows up on income statements. Cost of goods sold is an essential component when calculating gross profit and gross margin. Gross profit is calculated by subtracting COGS from revenue.
To do COGS calculating successfully, a business needs to carefully track its inventory, as calculating COGS requires accurate inventory figures. Most businesses will conduct periodic inventory costing, concentrating on the end and beginning of the year.
Understanding the cost of goods sold is crucial to running a successful business.
What is the COGS Formula?
The cost of goods sold formula:
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 that your business had a beginning inventory of $10,000. There are also $4,000 of costs (purchases), you have $2,000 inventory remaining; that gives a COGS of $12,000 for the accounting period.
COGS= $10,000+ $4,000 -$2,000 = $12,000
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 inventory.
At the start of each year, any products that got sold in the previous year are removed from the beginning inventory. Once you calculate the total costs of the beginning inventory, as well as all purchases during the period; the resultant number will be subtracted from the sum of beginning inventory and purchases to give your cost of goods sold.
With Profit Frog, business owners don’t need to stress about calculating costs, finding some extended COGS formula, or trying to calculate OPEX. Just follow our prompts and see how easy budgeting and forecasting can be.
We give you a clear view of your company’s sold COGS and show you where you can increase profitability.
By adjusting business variables within your forecasting dashboard, you will be able to predict future scenarios. This is better known as scenario planning; it will guide you through uncertainty and lead your company to success.
COGS vs Operating Expenses in SaaS
Preferably, a SaaS business should have a profit margin of 40-50% and a gross margin of 80-90%. Having correct coding of operating expenses vs COGS is crucial for multiple reasons. Correct expense coding for COGS vs OPEX will give you the necessary data to optimize your company’s profitability.
Profit Frog gives SaaS companies clear visibility into COGS, OPEX, and other critical factors. Armed with these insights, they can navigate uncertainty with our profitability modeling software.
Cost of Goods Sold Formula With Gross Profit
Gross profit calculations measure business efficiency. By subtracting the cost of goods sold from revenue, you derive the gross profit number.
How to calculate the gross profit margin:
Gross Profit Margin = (Revenue – COGS) / Revenue x 100,
Using this formula will show you the ratio of your revenue the business keeps after COGS are deducted. This formula indicates how successful your business is at generating revenue while keeping expenses low. You can use a profit modeling tool to make calculations easier…and to ensure accuracy.
By using Profit Frog’s profit modeling software, you will simplify budgeting and track your business’s profit. Having a clear picture of what COGS and gross profit are and how they work will reduce any uncertainty and fears.
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%
The gross profit margin will vary across sectors and production, but it’s commonly used to measure the profitability of a singular product. It will indicate how efficiently you are utilizing the resources in order to produce the goods or deliver your service.
Accounting Methods and COGS
The value of COGS will depend on your inventory accounting method. There are three methods available for calculating inventory sold during a particular period:
- First in, first out (FIFO)
- Last in, first out (LIFO)
- The average cost method
- 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.
- 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.
- 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. Taking the average product cost over a specific time frame will even out extreme fluctuations in COGS over time.
COGS Frequently Asked Questions
What is included in COGS?
The cost of goods sold includes all the costs of manufacturing or developing a product. For example, 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.
Companies that sell and manufacture products need to have these five fixed costs and variable costs incorporated in COGS:
- Raw materials
- Storage cost
- Transport costs
- Tools and parts used during the production
- Factory labor
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 cost of the inventory your small business sold during an accounting period.
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. Gross profit is listed below COGS. It is listed there because gross profit is calculated by subtracting COGS from revenue.
How is the cost of goods sold classified in financial statements?
COGS is a business expense when you are looking at a financial statement. 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 COGS 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.
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, Profit Frog strips forecasting down to the thing that matters most: profitability. Our profitability modeling solution allows you to quickly assess the health of your business, 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.