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 profitability modeling software not only tracks expenses and revenue—it allows you to predict future profits based on adjusting your different business drivers.
What Is The Cost Of Goods Sold?
The cost of goods sold, sometimes termed cost of sales, are direct costs associated with producing goods or providing a service. They include raw materials and direct labor.
Generally accepted accounting principles (GAAP) define COGS as the general cost of producing items sold during a selected period.
Our COGS definition: all expenses directly related to producing a product or delivering a service.
Understanding the cost of goods sold is crucial to running a successful business. Our small business forecasting software includes a handy COGS calculator to make COGS—and all other aspects of budgeting and forecasting—much simpler.
What’s 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 COGS:
- Product storage costs
- Product transport costs
- Tools and parts used in production
- Raw materials
- Factory labor costs
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.
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
Cost of Goods Sold Formula With 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 product. It will indicate how efficiently you are utilizing the resources in order to produce the goods or deliver your service.
How to calculate gross profit margin:
Gross Profit Margin = (Revenue – COGS) / Revenue x 100
This formula indicates how successful your business is at generating revenue while keeping the cost of goods sold low.
Rather than focus 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.
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 method, the LIFO method, and the WAC method. All three are formulas to value your inventory—and to derive COGS from inventory values.
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.
Plus, calculating cost of goods sold is much easier when you use Profit Frog.
COGS Frequently Asked Questions
What is the difference between COGS and OPEX?
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. COGS plus OPEX equal total costs.
OPEX includes most overhead costs, including:
- Legal costs
- Insurance costs
- Office supplies
- Interest paid on debt
- Administrative expenses
- Human resource costs
- Marketing 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.
Cost accounting and forecasting become easier with Profit Frog.
Is COGS an operating cost?
While COGS is a business expense, it is not considered an operating expense. OPEX are costs incurred in daily operations, regardless of sales volume.
Operating expenses and COGS are mutually exclusive. If an expense is COGS it is not OPEX and vice versa.
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 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.
Does COGS include salaries?
Cost of goods sold does not include salaries, overhead costs as well as any other general and administrative expenses. The key takeaway to determine whether labor is COGS: if the labor was involved in manufacturing a product or delivering a service, it’s COGS. If not, it’s not.
Is COGS connected to inventory?
Calculating COGS is crucial for tracking inventory items. Most companies will perform periodic inventory costing; focusing on the beginning and end of the year or quarter.
Profit Frog calculates COGS in real time, rather than doing a retroactive inventory accounting after a calendar year (or month, or quarter) has closed. Our approach gives entrepreneurs more control and proactivity.
Small business owners plug in all their costs, including cost of goods sold, into their dashboard and see a current 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 COGS, OPEX, 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.
With our tools, business owners don’t need to stress about calculating costs, finding the correct cost of goods sold, or trying to calculate OPEX. Simply follow our prompts and see how fast and easy budgeting and forecasting can be.
Exclusions from COGS
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, and other overhead.
How to calculate COGS?
The traditional cost of goods sold formula is unwieldy and backward-looking because it is based on calculating inventory at the beginning and end of a prior accounting period. Here’s the traditional formula to calculate the cost of goods sold (but there’s a better way):
COGS = Beginning Inventory + Cost of 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
Small 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. Simply follow our prompts and see how quick and 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.
What is the relationship between COGS and gross profit?
Cost of goods sold is a key component when calculating two vital 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
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 flow and other factors, Profit Frog strips forecasting 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.