How to calculate your COGS percentage

Cost of goods sold (COGS) percentages are used as profitability metrics for services and products. Your company’s COGS percentage is a ratio of COGS to revenue.

Here’s how to calculate the cost of goods sold percentage (but if you use Profit Frog, you don’t need to worry about the rest of this article—we do COGS calculations for you).

Profit Frog simplifies calculating COGS, profitability, and operating expenses. Our financial planning and analysis (FP&A) software cuts the fluff for small businesses.

What Is The Cost Of Goods Sold?

The cost of goods sold, also referred to as cost of sales, are the direct costs associated with producing a good or providing a service. Usually, they will include direct labor costs and raw materials.

COGS Definition

According to generally accepted accounting principles (GAAP), COGS is the overall cost of manufacturing items sold during a selected period.

Our COGS definition: all direct costs involved in manufacturing a product or delivering a service.

COGS Accounting

COGS calculating, in the traditional model, is backwards-looking and is based on inventory valuations. A business compares inventory at the beginning and end of an accounting period. Most often, such inventory costing occurs annually.

For most small businesses, there’s a better way to do COGS accounting.

We take a real-time approach to COGS. Business owners regularly 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 based on hypothetical future scenarios. This is a discipline called scenario planning. Traditionally, it’s been something large organizations do. We make it easy for small businesses.

With Profit Frog, business owners don’t need to stress about calculating costs, finding the correct cost of goods sold formula, or trying to calculate OPEX. Just follow our prompts and see how stress-free budgeting and forecasting can be.

Where is COGS Used?

Along with revenue, COGS also shows up on income statements.

Cost of goods sold is a key component when calculating gross profit and gross margin. Gross profit is calculated by subtracting COGS from revenue.

Understanding the cost of goods sold is crucial to running a successful business, and we help you track COGS proactively so you can be in the driver’s seat of your business. Our software has a built-in COGS calculator and makes budgeting and forecasting easy.

What is the Cost Of Goods Sold Percentage?

The cost of goods sold percentage is a ratio of COGS expenses to revenue. The cost of goods sold percentage is also referred to as:

Cost of goods sold ratio
Selling cost to sales ratio
Cost of sales to revenue ratio

The COGS percentage is a marker of business efficiency. It is the first step to calculating the gross margin ratio. Cost of goods sold percentage is also used when calculating gross markup.

What is the COGS Formula?

The traditional cost of goods sold formula is based on beginning and ending inventory and is backwards-looking. We prefer real-time COGS calculations.

Inventory-based COGS formula

COGS = Beginning Inventory + Purchases during the period – Ending Inventory

Beginning inventory: a business’s inventory purchased 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.

Cost of Goods Sold Example Using the Inventory Formula

If your business had a beginning inventory of $10,000, and there are also $4,000 of costs (purchases during a specific period of time), 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 for the period; the resultant number will be subtracted from the sum of beginning inventory and purchases to give your cost of goods sold.

With this traditional COGS formula, 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.

Profit Frog’s Approach to COGS Calculations

We take 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. They can see in real time what their business profitability will be under these scenarios. This is called profitability modeling, and it’s crucial for helping small businesses navigate uncertainty.

Cost Of Goods Sold Percentage Formula

To calculate the cost of goods sold percentage, just divide COGS by total revenue and then times the resultant number by 100.

The formula for calculating COGS percentage: (COGS / Total revenue) X 100

COGS Percentage Example

A shoemaker has spent $900 on inventory items during a fiscal quarter and had $300 worth of inventory on hand at the end of the quarter. He sold 100 shoes for $50 per pair during the quarter.

First, calculate COGS: 1000 + 900 – 300 = 1600
Calculate total sales: 100 x 50 = 5,000
Calculate the COGS percentage: 1600 / 5,000 = 0.32
Times by 100: 0.32 x 100 = 32

The shoemaker has a COGS percentage of 32%.

Accounting Methods and COGS

When it comes to calculating COGS, there are three traditional methods. They are all based on inventory valuations; they are also backward-looking.

All three formulas derive the cost of goods sold from beginning and ending inventory values, meaning they aren’t of much use to the entrepreneur trying to get a handle on current and future COGS.

We don’t recommend any of these three methods for small business owners. Instead, we recommend a real-time cost of goods sold tracking model. But here they are.

Inventory-Based COGS Accounting Methods

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.

Keep on reading and find out why small businesses need a better way to keep tabs on expenses.

Actionable Expense Tracking

Rather than backward-looking accounting methods, Profit Frog offers real-time visibility into a company’s profit centers and costs, including COGS.

The common mistake many small business owners make is deferring COGS calculations until after the books are closed on an accounting period. This mistake can harm your business since you don’t have a real grasp on your business’s cost of goods sold. This will result in not knowing where to focus cost reduction efforts.

In addition to modeling costs (OPEX and COGS), Profit Frog allows small businesses to model growth, new market opportunities, and other variables.

COGS Frequently Asked Questions

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.

Get started with your free Profit Frog trial today

What’s included in COGS?

COGS includes all manufacturing costs, factory labor, and other direct expenses involved in creating a product or providing a service.

Small businesses owners that manufacture or sell goods should have these variable costs included in COGS:

Storage costs
Transport costs
Tools and parts used during the production
Raw materials
Factory labor costs

Indirect costs like payroll and rent are not included in COGS.

What is the difference between COGS and OPEX?

COGS and operating expenses are different categories of costs incurred by a business. COGS and OPEX values are recorded as separate items on company income statements.

OPEX includes:

Rent
Utilities
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.

OPEX vs COGS calculations are difficult and confusing for an average small business owner. Profit Frog makes calculating operating expenses vs COGS easy and efficient.

Get started with your free trial today!

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 tools will help you navigate uncertainty and have correct summaries. It will help you understand how modeling your financial profitability will improve your business performance.

Is Cost of Goods Sold a Debit or Credit?

The cost of goods sold is an expense account on your income statement, making it a debit. In other words, it is a business factor that you want to minimize.

Credits are good and you want to maximize them
Debits are necessary costs but you want to minimize them

When you are able to reduce debts while keeping credits constant (or even better, increasing credits), your company’s profitability increases.

Similarly, when you increase credits while keeping debits constant (or even better, reducing debits), your company’s profitability likewise increases.

Increasing profitability is the main goal that Profit Frog aims to help business owners achieve.

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 accounting.

Assets
Expenses
Equity
Revenue
Liability

COGS is an expense account on an income statement, making it a debit. Because COGS is a debit, not an asset, it is a business factor that should be minimized.

Even though accounts receivable and inventory are assets on the balance sheet, only some expenses on income statements will involve these items. The cost of goods sold on an income statement traditionally reports the cost of the inventory a business sold during an accounting period.

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.

Get started with your free Profit Frog trial today!