The Cost of Goods Is: Let's Get to Know From Understanding to How to Calculate It

Calculating COGS or cost of goods sold (COGS) for the products you produce or sell is very important if your business sells products. This calculation includes all costs involved in selling the product. Calculating COGS for the products you manufacture or sell can be a tricky task, depending on the number of products and the complexity of the manufacturing process.

Do you want to know more about COGS? To broaden your understanding, keep reading this article until it's finished!

What is Cost of Goods?

The cost of goods sold for each of the company's production activities is known as the Cost of Goods Sold (COGS).

COGS as a whole includes all costs required by a company to make goods or services, including the manufacturing process until the product is ready for market.

COGS is a calculation that includes the cost of raw materials, direct labor, and operational costs. However, it does not include indirect expenses such as shipping costs and employee salaries.

Cost of Goods Benefits

If a business uses the cost of goods sold (COGS) calculation, the benefits include the following:

• Based on production costs, product specifications, and the number of requests, the company can determine the right selling price to be charged to the buyer.

• A tool to monitor the realization of production costs and find out whether the production process of a particular product results in the total production costs that were calculated before.

• Helps calculate profit or loss: if the selling price is higher than COGS, the company will make a profit, and if the selling price is lower, you will incur a loss.

Costs Included in COGS

As is known, COGS is the total cost incurred by the company during the process of producing goods or services. Among the costs included in the COGS are:

1. Purchase

Goods included in stock in previous production periods are referred to as inventory here.

Inventory cost in COGS can be calculated by aggregating the amount of merchandise purchased during the current period, then deducting the ending inventory.

The number of finished products represents the inventory of goods sold by trading companies.

However, in the manufacturing business, inventory of goods sold consists of raw materials, goods in the process of production, and final products.

2. Direct Labor

Costs or wages given to employees by companies directly involved in the process of producing merchandise are referred to as direct labor.

Because the wages paid to employees depend largely on how many units of product they can produce, they are called direct labor.

Most manufacturing companies have direct labor costs.

3. Other Fees

Building rent, machine depreciation, electricity and water, packaging, and maintenance of equipment are additional costs included in COGS.

These types of costs depend on the scale of the business, its type, and the resources used.

The formula for calculating the Cost of Goods Sold (COGS)

To calculate the cost of goods sold (COGS), the following formula will be used:

• Net sales = gross sales - sales returns - sales allowances
• Net purchases = purchases - purchase freight costs - purchase returns - purchase discounts
• COGS = beginning inventory + net purchases - ending inventory
• Gross profit = net sales - cost of goods sold
• Net profit before tax = gross profit – accumulated costs

Way to calculate COGS

We can use several ways to calculate COGS based on the formula above.

1. Determining the Type of Financing 

COGS is a calculation that allows company owners to reduce the total cost of products sold. You have to compile all the costs needed, including labor, supplies, and raw materials, as well as other production needs.

You can also divide the types of financing into two categories: direct and indirect. Direct labor, operations, and raw materials are direct financing targets.

However, indirect financing goes to indirect employees, such as delivery or packaging employees.

2. Choose Operational Costs

Operational costs can be calculated as a percentage of facility costs (such as building rent, electricity and water) for each product over a period of time.

3. Identifying Inventory (Beginning, Addition, and End)

Raw materials, semi-finished products, and scrap from previous periods are included in inventory. Most companies are constantly adding inventory items, so you should know how much is being added.

You must determine the tax charge for the goods made and keep relevant invoices or documents. You also have to determine ending inventory, which is the remaining items that are damaged, lost, or obsolete.

4. Calculate COGS

You can perform COGS calculations using Microsoft Excel or Google Sheets after getting the information from the previous step.

It is a complete explanation of what COGS is, including formulas and ways to calculate it, and its benefits.