This is an important ratio used to measure how well a company generates sales from its inventory. It shows how many times a company has sold and replaced inventory during a given period. The average inventory can be found by adding the beginning and ending inventory and then dividing the total by two.
Quick Tip: There are tons of other accounting formulas that you can use to manage cash flow and business operations.
Regardless of whether you employ an accountant or bookkeeper, understanding the basics of these accounting methods will help you to achieve and maintain profitability. To learn about the various accounting methods, financial statements and fundamental accounting tasks, read our complete guide to accounting for startups.
A good product price allows you to cover your costs while leaving you a healthy profit margin. Knowing your COGS can help you determine exactly when you need to increase or decrease your prices. Once complete, dive into our guide that explores 6 steps on how to price a product and achieve profitable markups.
By finding out the cost of your production processes and using COGS to calculate different ratios, you can better understand the overall financial health of your company. This helps you make decisions like whether you need to invest more in your operations or improve the way you manage your inventory. It also helps you figure out whether you can afford to pay back your debts, if you should cut down on payroll costs, or if you should completely shut down your business operations.
Knowing your COGS can help you effectively manage your taxes and avoid getting into legal trouble. But, although paying less taxes can effectively save your business money,high COGS can also mean that your business is not making enough profit.
You need to find a healthy balance to ensure efficiency and profitability for your business. Historical changes in COGS can help your business find seasonal trends in the costs of raw materials.
In order to figure out these historical changes, analyse your COGS over the past few years, for example, to decipher seasonality variations. You may notice that your COGS are consistently higher in the winter months. If so, this information can be used by businesses to identify areas of growth and improvements.
Quick Tip: Another way to efficiently identify growth opportunities is by creating a cash flow forecast. This process can help you make better strategic business decisions by estimating sales, income and general business expenses over a 12 month period. To learn more, read our article that explains what a cash flow forecast is and how to create one.
COGS can, unfortunately, be altered or manipulated to show a favourable or unfavourable situation of a business. COGS can also be over-reported to avoid paying taxes to the government. Conversely, they can be under-reported to make the company look like more of an attractive prospect to investors. For a small business, effectively managing costs and operations is key to higher profits and, ultimately, survival. Keeping track of your COGS will help you better understand which areas of production are eating up most of your money and where you can increase efficiency.
Tracking your COGS will help you make smarter business decisions and help you improve the overall financial health of your business. Photo by Andrea Piacquadio, published on Pexels.
Be the first to hear about our webinars, new features and business tips to help you save time and money. Contact our Support team now on phone In this article, we define COGS and cost of sales, explain how to calculate cost of sales and answer some frequently asked questions. It can also refer to the cost of buying products and reselling them. COGS have two types: direct costs and indirect costs.
This refers to the cost directly tied to making a particular good or service. Examples of direct costs include:. Examples of indirect costs include:. Also known as the cost of revenue, the cost of sales refers to the total accumulated cost a business incurs to create a good or service for its customers to purchase.
Like COGS, the cost of sales includes all direct costs associated with these goods and services. While the cost of sales can let you know the operational costs of producing a good or service, it can also help in another regard. For example, if the cost of sales continues to rise but revenue remains the same, it could indicate an increase in input costs.
While some companies list either COGS or cost of sales on their balance sheets, some include both terms. Since they're often used interchangeably, it can create confusion as to how they truly differ. The following are answers to some common questions about cost of sales and COGS.
Businesses that only offer services as opposed to products often use cost of sales or cost of revenue instead of COGS because they don't have operating expenses tied to tangible goods.
However, service providers may offer small products, such as resorts selling branded souvenirs or airlines selling food and drinks to passengers. When they do, these items are categorized as costs of goods sold. Therefore, businesses try to keep their COGS low in order to have a higher net income.
There are lots of ways are available to increase or decrease COGS. It all depends on what strategies the company chooses to employ. How to increase or decrease the cost of goods sold? Introduction: Cost of goods sold also referred to as the cost of sales is the cost you incur to make your products or services.
Related article Cost of goods sold for a food business - Explained.
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