If you run a firm that sells items, you need to know your cost of goods sold (COGS). One of the essential accounting concepts and small business accounting principles that every business owner should understand is the cost of goods sold. The cost of products sold is a significant factor in setting product prices.
Understanding COGS and how to manage its various components might be the difference between a profitable and a non-profitable business.
The explanation of Cost of Goods Sold (COGS), why you should know your COGS, four inventory cost techniques for the cost of goods sold, the COGS formula and sample calculations, and how to calculate COGS in six easy stages are all covered in this article. COGS stages and restrictions.
Let’s get this party started.
What is the cost of goods sold?
The cost of providing the products or services you sell is the cost of goods sold (COGS). The cost of purchasing and transforming products or services to a saleable state is COGS. It covers the cost of any direct materials or services used to create the final product supplied to customers.
The cost of products you don’t sell and overhead is not included in the price of goods sold (COGS). Adding overhead to COGS is a common blunder.
Overheads are direct or indirect expenses required to run a firm but are not included in COGS. Utility bills, employee salaries, marketing costs, and transportation rates, among other things, are not included in COGS but are considered overhead.
The price of the foam, sheets, and threads used to construct a mattress is its COGS if you own a mattress manufacturing business. It does not include the expense of marketing the goods and shipping them to your customer’s location.
In addition, there is a distinction to be made between COGS and inventory cost. Only inventory costs cover only the cost of things that have not yet been sold but are ready to be sold. COGS refers to the cost of items that have already been sold. Cost of goods (COGS) is sometimes known as “cost of sales” or “cost of services.”
Cost of Goods Sold & Cost of Goods Manufactured is not the same (COGM). Creating the cost of goods sold (COGS) refers to production costs. COGM stands for “cost of goods manufactured” and includes all expenses associated with turning inventory into a finished product, such as direct labor, direct materials, factory overhead, and other related costs.
Why you need to know your COGS
When running a business, you must be aware of your COGS. It is critical to determine the various components that make up your company’s financial aspect. The following are a few reasons for this:
COGS helps you choose the right price
Costing a product can be a difficult task. It is especially suitable if you are the manufacturer of a product that does not have universal pricing.
It would help if you made profits, and the number of money customers pay for your items determine how much profit you make. Knowing your COGS supports you in choosing the right price that gives you a healthy profit margin. You don’t want to set a cost that is less than the cost of production. You will undoubtedly lose money.
You can tell when you must raise a product’s price, and you can even establish competitive prices to entice more buyers.
For example, if the cost of goods sold (COGS) is $100, you know that the product’s price must be higher than $100 to profit.
You can quickly determine your overall profitability.
Your gross profit is your company’s money from selling its products or services before taxes and other costs are deducted. Your net profit is the amount left over after all taxes, and additional charges have been removed.
Knowing your company’s cost of goods sold is crucial to estimating your overall earnings. Why do you need to know your company’s overall profits? You have the option to inquire.
You can determine your profitability and financial performance by knowing your gross and net income. It assists you in making better financial decisions and identifying areas for improvement.
Companies have a general concept of production costs and can assess if they are excessively high or deficient. Then they can improve the overall profitability of the company’s operations.
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