Calculating Costs of Goods Sold – Everything You Need to Know
Calculating Costs of Goods Sold
How do you calculate your cost of goods sold? The value of your inventory will be used to calculate your COGS. You may buy products from a wholesaler or create them yourself and resell them. It could also be parts and materials used to make your products.
All of these items have a specific value and can affect your COGS. Many businesses take inventory at the beginning and end of the year to determine their COGS.
Keeping track of all your inventory at the start and end of each year
Keeping track of all your inventory at the beginning and end of each year is vital for calculating costs of goods sold. It’s also necessary to determine your starting inventory, which includes raw materials, items that you’ve already started making, and supplies.
You’ll need to match the beginning inventory to the end inventory, as these figures should match up exactly.
FIFO or First In, First Out is an accounting method. FIFO is a method that assumes your most recent inventory will be sold first, and the cost of your latest inventory is added to COGS before any purchases from earlier periods.
The ending inventory is the total value of your sellable inventory at the beginning and end of each year.
COGS is a key part of tax reporting, and it’s crucial for businesses that sell products or buy and resell goods.
COGS is a financial measurement that includes the cost of your direct materials, direct labor, and any overhead expenses that go along with your products.
You can use the cost of goods sold to minimize your taxes. If your company sells ceramic mugs online, for example, you’d include the cost of clay, paint, mug accessories, boxes, and labor to assemble them. But the cost of your electricity bill and your social promotion budget would not be included in your COGS report.
Adding up direct and indirect costs
Indirect costs refer to the materials and supplies that go into making your products. They are not associated with any particular service.
These include utility bills, rent, and cell phone costs. Indirect costs are both fixed and variable. They can vary a great deal from one business to another, so it is important to be aware of them.
A business should price its products and services so that they cover both direct and indirect costs.
Adding up direct and indirect costs of goods and services is essential in accounting. Without a solid understanding of COGS, a business will have a hard time identifying break-even points.
For example, a mechanic who earns mostly from service fees may be spending more on car parts than on services. But, a yoga instructor may sell yoga mats, apparel, and other items that are considered indirect costs.
Keeping track of all your overhead costs
Keeping track of all your overhead costs when you’re selling goods and services is very important. Overhead costs can often be underestimated and can have a significant impact on the bottom line of a business.
If you don’t keep track of these costs, you may make mistakes in pricing your goods or services, resulting in a loss of profit or a slow inventory turnover. This is especially harmful if you’re selling perishable goods or services.
The easiest way to determine the amount of overhead costs you have when selling goods and services is to look at your income tax report or annual expense report.
You don’t need to keep track of every single transaction, but the income tax return is a great resource to consult when calculating overhead costs.
Although the numbers on your income tax or expense report will include expenses like rent and property tax, you may want to consider monthly expenditures when calculating your overhead costs.
Finding the sweet spot in calculating COGS
As you grow, the cost of goods you sell will increase. More products mean more production costs. However, you can lower costs by offering volume discounts. Pricing products correctly is crucial to the success of your business.
COGS can be divided into two main parts: materials and overhead. If you’re calculating COGS for a restaurant, the sweet spot should be less than 31% of total revenue.
Using the average cost method,
you’ll be able to see exactly what materials and overhead are costing you each month.
The beginning inventory includes the materials you already have on hand before making new purchases. This starting inventory amounts to $5,000.
Then, you add another 5,000 units at the same cost and you have a total of $10,000 in inventory to sell. However, the cost of these materials is not the only factor affecting COGS.
Other expenses include product obsolescence, depreciation, and stockouts. As your inventory grows, the value will increase or decrease depending on factors out of your control.
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