What is Cost of Goods Sold (COGS) and How to Calculate COGS

What is COGS


What is Cost of Goods Sold and How to Calculate COGS

Cost of Goods Sold (COGS) is an important component in a company and is usually calculated by either a manufacturing company or a trading company.

The article below will explain the meaning, purpose, benefits, and examples of how to calculate it for a trading company and a manufacturing company.

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What is Cost of Goods Sold (COGS)

Cost of Goods Sold or COGS is a term in accounting/finance which is used to describe the total direct expenses by a company arising from goods and/or services produced and sold in business activities in a period, generally monthly and annually.

The calculation of the value of COGS includes direct costs that affect finished goods or services sold, complete with raw material costs, direct labor costs, and overhead costs, but does not include indirect costs such as sales, advertising, research, and development.

Purpose of Calculating Cost of Goods Sold

The purpose of calculating the COGS is to measure the actual cost of producing merchandise or services purchased by customers for a certain period. Of course, by being able to calculate the correct cost of goods and services being sold, we can accurately determine the right selling price for our customers, so that we can find out how much profit we get in a certain period.

In addition, the calculation of Cost of Goods Sold or COGS is very important for management because it can help management analyse how well they control the purchasing costs and labor costs (wages / salaries). Creditors or investors can also use Cost of Goods Sold (COGS) to calculate the gross margin of the business and analyse what percentage of income is still available to cover operational costs. Manufacturers and retailers (retailers) will definitely record Cost of Goods Sold into their Income Statement as a direct expense after revenue for a certain period. The cost of goods sold, or COGS is then deducted from the Total Revenue to find out the Gross Margin.

Also Read: How to Calculate the Selling Price of Your Product to Get Big Profits?

Cost of Goods Sold (COGS) formula and how to calculate COGS

The COGS formula is calculated by adding Net Purchases to the Beginning Inventory for a given period and then subtracting Ending Inventory for that period. The following is the formula for the cost of goods sold (COGS).

Cost of Goods Sold (COGS) = Net Purchases + Beginning Inventory - Ending Inventory

  1. Net Purchases
    Net Purchases are all purchases of merchandise made by the company, for the purchase of cash or credit, plus direct costs such as freight. purchases are reduced by purchase discounts and purchase returns, in order to obtain a net or actual purchase value for a period.
  2. Beginning Inventory
    Beginning inventory of merchandise is inventory that is available at the beginning of the company’s accounting period, for example, the beginning of the month or the beginning of the year. The balance of the beginning inventory of this item can be checked on the current period trial balance or the company’s beginning trial balance in the previous year.
  3. Ending Inventory
    Ending merchandise inventory is inventory of goods that are available at the end of the company’s accounting period, for example at the end of the month or at the end of the current financial year. This balance value is generally obtained from stock-taking or physical stock calculations, for companies that have not used stock or accounting applications.

Example of Calculating The Cost of Goods Sold (COGS) at a Trading Company


A retail store that sells snacks that is completing its financial statements at the end of 2019 and calculating the amount of inventory as shown in the following data:

Known:
Beginning Inventory 2019 = Rp. 300.000.000,-
Net Purchases 2019 = Rp. 500.000.000,-
Ending Inventory 2019 = Rp. 200.000.000,-

Solution :
COGS = Net Purchases + Beginning Inventory - Ending Inventory
COGS = Rp. 500.000.000 + Rp. 300.000.000 – Rp. 200.000.000
COGS = Rp. 600.000.000

So, the snack retail shop sells merchandise for Rp. 600,000,000, – during this year and the leftover inventory/goods with a value of Rp. 100,000,000, – on December 31, 2019.

This information will not only help the retail store plan purchases for the next year but will also help it evaluate its costs. This COGS can also provide information about the sales margin for each product if a classification is made for each product category. Thus, management can find out which products are the most profitable and make the most money.

Currently using the Sales and Inventory application, Inventory counting will be carried out automatically at the time of input of Purchase of Goods and Sales of goods. Thus the final Stock will always be updated real-time, and of course the Cost of Goods Purchased will be calculated automatically by the system at any time, without the need to wait for the end of the period or the end of the year. In addition, COGS can also be found in detail by item, by category of goods, and total company.

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The formula for the Cost of Goods Sold (COGS) in a Manufacturing Company


Calculation of Cost of Goods Sold in manufacturing companies is much more complicated than trading companies. This is because in trading company only buys and then sells the same goods, so that the costs arising from the goods purchased are not large, generally only freight costs. But in manufacturing companies, because there is a change in goods from raw materials and then processed into finished goods. Therefore, to calculate the cost of goods sold (COGS) for a manufacturing company, is to use the following formula:

Cost of Goods Sold (COGS) = Cost of Goods Manufactured (COGM) + Beginning Inventory of Finished Goods - Ending Inventory of Finished Goods

Cost of Goods Manufactured (COGM) is the price obtained from the raw materials used plus the production costs incurred for converting raw materials into finished goods.

Here are the steps to calculate Cost of Goods Manufactured as follows:

  1. Calculating the Raw Materials Used
    The raw materials used can be calculated with the following formula:
    Raw Materials Used = Beginning Inventory of Raw Materials + Purchase of Raw Materials - Ending Inventory of Raw Materials
  2. Calculating Production Costs
    Production costs can be calculated by the formula below:
    Total Production Costs = Raw Materials Used + Direct Labour Costs + Production Overhead Costs
  3. Calculating the Cost of Goods Manufacture (COGM)
    To calculate the Cost of Goods Manufacture (COGM), a formula is needed as follows:
    Cost of Goods Manufactured (COGM) = Total Production Costs + Beginning Inventory for Work in Production - Ending Inventory for Work in Production

Example of calculating the cost of goods sold (COGS) in a manufacturing company


In the previous example, we used a snack retail shop that only buys goods and then sells. Then the business owner wants to do his own production of some snack items that are selling well. One of them is cassava cracker snacks, this is done so that he can get more profit and sell his products to other shops outside his own shop.

In this example the company has an inventory of raw materials at the beginning of the year of Rp. 300 million, semi-finished goods (goods in the process of production) of Rp. 200 million and supplies of Finished Goods that are ready for sale are Rp. 500 million at the beginning of 2019. In the same year, this company purchased raw materials for Rp. 800 million with a delivery fee of Rp. 80 million. Labour and machine maintenance costs during 2019 are Rp. 150 million. At the end of 2019, the remaining use of raw materials is Rp. 200 million, the remaining inventory in process is Rp. 100 million and the remaining finished products that can be sold are Rp. 300 million. What is the cost of goods sold or the company’s COGS?

Known:
Beginning Inventory of Raw Materials = 300.000.000
Beginning Inventory for Work in Production = 200.000.000
Beginning Inventory of Finished Goods = 500.000.000
Purchase of Raw Materials = 800.000.000
Delivery Fee = 80.000.0000
Labour and Machine Maintenance = 150.000.000
Ending Inventory of Raw Materials = 200.000.000
Ending Inventory for Work in Production = 100.000.000
Ending Inventory of Finished Goods = 300.000.000

Solutions:
The calculation of Cost of Goods Sold for this example case must be calculated through 4 stages as mentioned earlier.

  1. Calculating the Raw Materials Used
    Raw Materials Used = Beginning Inventory of Raw Materials + Purchase of Raw Materials - Ending Inventory of Raw Materials

    Raw Materials Used = 300.000.000 + (800.000.000 + 80.000.000) – 200.000.000
    Raw Materials Used = 980.000.000

  2. Calculating Production Costs
    Total Production Costs = Raw Materials Used + Direct Labour Costs + Production Overhead Costs

    Total Production Costs = 980.000.000 + 150.000.000
    Total Production Costs = 1.130.000.000

  3. Calculating the Cost of Goods Manufacture (COGM)
    Cost of Goods Manufactured (COGM) = Total Production Costs + Beginning Inventory for Work in Production - Ending Inventory for Work in Production

    Cost of Goods Manufactured (COGM) = 1.130.000.000 + 200.000.000 – 100.000.000
    Cost of Goods Manufactured (COGM) = 1.230.000.000

  4. Calculation Cost of Goods Sold (COGS)
    Cost of Goods Sold (COGS) = Cost of Goods Manufactured (COGM) + Beginning Inventory of Finished Goods - Ending Inventory of Finished Goods

    COGS = 1.150.000.000 + 500.000.000 – 300.000.000
    COGS = 1.430.000.000
    Then the Cost of Goods Sold in the Manufacturing Company is Rp. 1.430.000.000,-

After we see that calculating the Cost of Goods Sold is very important so that we can know exactly how much capital we actually spend on the goods or services we sell. This of course will increase our awareness so that we do not only focus on increasing our sales, but it turns out that we miscalculate the COGS which will result in every item we sell instead of bringing profit but making us a lot of losses.

If we already know our COGS well, we can determine our selling price more easily and better, so that we can get optimal profits.

Also Read: How to Calculate the Selling Price of Your Product to Get Big Profits?

Hopefully, this Article Brings Benefits to You and Your Business
Cheers

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