Profit Frog simplifies understanding and calculating cost of goods sold. Our financial planning and analysis (FP&A) software was created specifically to aid small businesses.
What is the Cost of Goods Sold?
Cost of goods sold, also known as COGS, is a term that many people have trouble understanding. COGS measures the direct costs of producing a good or delivering a service, including raw material and direct labor.
Generally accepted accounting principles (GAAP), defines the cost of goods sold as the overall cost of producing the items sold during a selected period. Along with revenue, COGS will appear on the income statement.
COGS is the key component when calculating two business expenses: gross profit margin and gross profit. The gross profit is calculated by subtracting COGS from revenue.
Inventory and COGS go hand in hand. For there to be a successful calculation of business COGS, carefully tracking inventory is key. Most companies perform periodic inventory audits, focusing on the beginning and end of the year to monitor it closely.
What is COGS in Accounting?
Cost of sales, also called cost of goods sold (COGS), is an estimate of direct costs incurred in the production of goods sold by a business within a certain time frame. Cost accounting methods differ depending on the industry, but cost of goods sold measures direct costs like direct labor and materials; it excludes indirect costs like sales and distribution expenses.
For example, the cost of goods sold for a bakery would be the cost of labor used to make the baked goods and ingredients. Only costs directly linked to producing baked goods are included in the cost of goods sold. Costs that aren’t directly involved in the production of goods, such as distribution costs, utilities, and rent, are not included in COGS.
An essential part of calculating COGS is your inventory. The inventory balance consists of merchandise and products waiting to be sold, raw materials, and work-in-process products.
The merchandise that didn’t get sold in the previous year becomes the beginning inventory for next year. If the company buys or makes additional products, these will be added to the beginning inventory.
What is 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.
Small business owners don’t need to worry about the COGS formula when using Profit Frog. Our intuitive software guides you to enter your different expenses and categorizes them appropriately.
With Profit Frog, you will have a full grasp of your company’s COGS and gain insights into how you can increase profit.
You can then forecast future scenarios by manipulating all of your business variables. This is known as scenario planning, and it helps you navigate uncertainty and steer your company toward success.
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 your debits while keeping your credits constant (or even better, increasing credits), your company’s profitability increases.
Similarly, when you manage to 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.
How do I make a COGS Journal Entry?
Making journal entries for cost of goods sold can be a rather complex process. Fortunately, Profit Frog simplifies COGS accounting—and overall tracking of business profitability.
The traditional process of making a COGS account entry (also known as a COGS journal entry) for a business that makes or sells a product is as follows:
- Verify inventory balance for the beginning of the accounting period. This includes raw materials, finished products, and work-in-progress products.
- Calculate purchases for the accounting period. These are the accumulated costs of the inventory, including manufacturing overhead, raw materials purchases, and direct labor costs.
- Verify inventory balance for the end of the accounting period (closing inventory).
- Create the cost of COGS expense journal entry.
With Profit Frog, you don’t have to worry about the correct coding of COGS. We simplify budgeting and forecasting for small businesses. Your COGS and other business variables will be accurately tracked, and you will gain visibility into how you can best improve profitability.
Using Profit Frog’s financial modeling tools will help you navigate uncertainty and have correct summaries. We help you understand how modeling your financial profitability will improve your business performance.
How Do You Record the Cost of Goods Sold on T-Accounts?
T-accounts provide businesses with a visual representation of credits and debits. A double-entry accounting system means every transaction is recorded in two separate accounts;
Credits are on the right-hand side of the t-chart, and debits are always on the left-hand side of the t-chart.
Accounts receivable, inventory, and cash flow are considered asset accounts.
COGS, operating expenses, accounts payable, and other debt are debits. Each is considered a liability account.
You need both types of accounts—asset and liability—to operate a business. Each type of account is necessary. The liability accounts are not “bad”’; the goal is to minimize them in relation to gross income to arrive at higher net income, or profitability.
For example, you cannot manufacture a product without incurring some material cost. The goal is to incur the least material cost possible, while maximizing sales.
COGS Frequently Asked Questions
How to document the cost of goods sold in a journal entry?
Prior to documenting your cost of goods sold in journal entries, collect information in advance, such as beginning inventory balance, purchased inventory costs, and ending inventory count. Afterward, calculate the cost of goods sold.
By documenting inventory and purchases, you’ll have the info you need to create a COGS account entry.
When creating a new COGS entry , you should revise the inventory account balance; it should correspond to your ending inventory total.
If you want to make COGS accounting super easy, just use Profit Frog!
What is the cost of goods sold on an income statement?
Typical, COGS will be found directly underneath the total revenue when you are looking at a business’s income statement. Gross profit is usually listed below because you calculate it by subtracting COGS from the revenue. These numbers will give you a good idea of how your business is doing.
By using Profit Frog’s profit modeling software, you will simplify budgeting and track COGS and other expenses effortlessly. Having a clear picture of key business drivers will enable you to make strategic decisions that optimize the profitability of your company.
What is an inventory turnover ratio?
Turnover ratio, also known as inventory turnover, is the rate that products are sold and replaced. The formula for calculating the turnover ratio is:
Inventory turnover ratio = COGS * 2 / (beginning inventory + final inventory).
To calculate your turnover ratio, you’ll need to know the beginning balance and ending balance of inventory, as well as all COGS.
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—instead of pure sales revenue. 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.