Read on and learn why marketing is not a part of cost of goods sold.
Understanding what cost of goods sold includes is crucial for small business forecasting and budgeting.
Oh, and, by the way, Profit Frog takes a revolutionary approach to calculating COGS and to FP&A in general. We focus on what helps small businesses stay ahead of the curve. Our profit modeling tools not only track revenue and expenses—they allow you to predict future profits based on adjusting your different business drivers.
What is Marketing?
Marketing is a set of methodologies for growing consumer awareness and demand for products and services a business offers. Developing a good marketing strategy is done by researching and analyzing your target audience’s interests. Marketing is a core part of business success.
Why is Marketing OPEX?
Marketing is an indirect expense, because it isn’t involved in producing goods or delivering services. Since marketing doesn’t relate to delivering a service or product production, marketing can’t be included in COGS.
Because COGS and OPEX are mutually exclusive expense categories, marketing is part of operating expenses (OPEX).
What is OPEX?
Operating expenses are indirect expenses that are crucial to keeping any type of business running. Most businesses have at minimum, utilities, rent or lease, and office supplies to buy.
COGS versus operating expenses calculations are confusing for most business owners. Profit Frog simplifies expense tracking with our profit modeling software. Simply plug in your expenses, and use our profit modeling abilities to optimize your profit (net income).
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What is Included in OPEX?
Operating expenses are those costs necessary to sustain day-to-day operations, but which are not directly related to delivering a service.
The most common instances of OPEX are:
- Business travel
- Wages and salaries
- Property rates
- Legal fees and accounting
- Interest paid on debt
- Overhead costs
- Administrative expenses
What is Cost of Goods Sold?
Cost of goods sold 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.
Profit Frog’s COGS definition: all direct costs involved in manufacturing a product or delivering a service.
COGS for Service Businesses
If you own a service business (for example a housekeeping company), COGS will include business expenses involved in providing the service: direct labor, tools, and transportation costs.
COGS for Manufacturing Businesses
COGS, also referred to as cost of sales, measures the direct cost 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 direct 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 expenses under overhead costs (operating expenses).
COGS for SaaS Companies
Since SaaS companies provide their clients with software instead of physical products, calculating COGS is completely different than for a manufacturer. Since SaaS businesses have no “goods sold” most business owners will refer to this metric as cost of sales or cost of revenue.
SaaS COGS is important for correct accounting and modeling. Our SaaS business forecasting software includes a handy cost of goods sold calculator to make COGS—and all other aspects of budgeting and forecasting—much easier.
SaaS cost of goods sold includes:
- Application hosting and monitoring costs
- Data communication expenses
- Software license fees
- Website development and support costs
- Subscription costs
- Hosting costs
What is Included in COGS?
COGS includes all costs associated with manufacturing or developing a product. 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.
Manufacturing businesses should have these costs included in cost of goods sold:
- Product transport costs
- Product storage costs
- Raw material cost
- Tools and parts used in production
- Factory labor cost
If you own a service business (for example a plumbing company), the cost of goods sold will include business expenses involved in providing the service; direct labor, tools and parts used, and transportation costs.
Cost of Goods Sold Formula
There’s the traditional, backwards-looking way of calculating COGS. Then there’s the real-time, Profit Frog way.
Traditional Cost of Goods Sold Formula
The traditional, inventory-based cost of goods sold formula retrospectively calculates the cost of goods sold 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 Cost of Goods Sold with Profit Frog
Profit Frog takes a real-time approach to the cost of goods sold. Company owners plug in all their costs, including COGS, into their dashboard and see a real-time picture 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 OPEX, COGS, 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.
Calculating costs is easy with Profit Frog. 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.
Is Marketing Needed For Calculating Gross Profit?
When calculating your business’s gross profit margin, marketing expenses incurred during an accounting period are not used in the calculation. That’s because gross profit is derived by subtracting COGS from revenue. Marketing expenses are not included in COGS; ergo, marketing is not part of the gross profit calculation.
If all this is making your head spin, just use Profit Frog to organize your business finances. Easy peasy.
Calculating Gross Profit
Gross profit is one measure of business efficiency. Deducting the cost of goods sold from revenue gives gross profit.
Gross profit margin will vary across sectors, but it’s commonly used to measure the profitability of a singular service. It will indicate how efficiently you are utilizing the resources in order to deliver your service.
Gross Profit Margin Formula
Gross Profit Margin = (Revenue – COGS) / Revenue x 100
This formula indicates how successfully your business generates revenue while keeping the cost of goods sold low.
Instead of concentrating on gross profit, our customers benefit from optimizing for net profit. Net profit is what remains after all expenses have been paid: COGS plus operating expenses (OPEX). You’re in business to have as much net profit as possible, and we help you chart a course to maximum profitability.
Get started with your free Profit Frog trial today.
Frequently Asked Questions About COGS and Marketing
What are the traditional 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 valuation method, the LIFO method, and the WAC method. All three are formulas to value your inventory—and to derive COGS from inventory values.
What is not included in the cost of goods sold?
Direct expenses, also known as COGS, refer to any expenditures necessary for the production of goods or the delivery of services. Everything else is excluded from COGS
Not included in COGS: managerial expenses, advertising, utility expenses, lease payments, office supplies, marketing, and other overhead.
What are some limitations of 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 COGS 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 the actual value
Because the value of inventory can be artificially inflated, the cost of goods sold can be under-reported, which can show artificially-inflated 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
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Is the cost of goods sold 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.
Cost of goods sold 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 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.
The difference between cost of goods sold 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.
Selling, general, and administrative expenses are usually associated with the overall overhead as they can’t be directly traced to production.
Cost of goods sold doesn’t include distribution costs, which are SG&A expenses, according to generally accepted accounting principles. Hence, COGS vs SG&A calculation formulas are completely different.
What is supply chain management?
Supply chain management is the management of the production flow. It includes every process needed when transferring raw materials into physical products or delivering a service to a customer.
Are there businesses that don’t have listed COGS?
According to some definitions, certain service-based businesses can’t list COGS on their income statement because they have no inventory. Examples of such businesses would be SaaS companies, accounting firms, and commercial real estate brokerages.
Another perspective allows that service-based companies can still have COGS (which should probably be re-labeled as cost of services rendered, or COSR, even though we’re still going to use COGS for them). COGS for service businesses would be all the direct costs of delivering the service.
We prefer the latter definition, and help service-based businesses calculate their 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 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.