The cost of Goods Sold (COGS) in English is called the Cost of Goods Sold (COGS). The price of Goods Sold is an essential component of a company and is usually used by manufacturing and trading companies.
The article below will explain how to calculate the cost of goods sold or COGS and the COGS formula for trading companies and manufacturing companies. Come on, read the explanation sequentially to make it easier to understand.
What is Cost of Goods Sold (COGS)?
Cost of Goods Sold or COGS is an accounting/financial term that describes the total direct costs associated with goods and services produced and sold in business activities. Generally, the calculation is done based on one period, for example, monthly or yearly.
To calculate the COGS, you must calculate all the direct costs affecting the finished goods or services sold. For example, raw material, direct labour, and overhead costs. Meanwhile, indirect costs, such as selling, advertising, research, renting business premises, and development, are not included in the COGS calculation.
Purpose of Calculating Cost of Goods Sold
The purpose of calculating COGS is to measure the actual cost of producing the merchandise or services purchased by customers for a given period. In full, here are some purposes for calculating the Cost of Goods Sold (COGS):
- By calculating the true cost of goods and services sold, you can more accurately determine the right selling price for customers.
- You can find out how much profit you earned in a certain period.
- Calculating Cost of Goods Sold (COGS) will help management analyze how well they are controlling purchasing costs and labour costs (wages/salaries).
- Creditors or investors can use the COGS to calculate the gross margin of a business (gross margin) and analyze what percentage of revenue is still available to cover the company’s operational costs.
- Manufacturers and retailers (retailers) will record COGS in the income statement as a direct expense after revenue in a certain period. The cost of Goods Sold is then subtracted from the total revenue to find the gross margin.
How to Calculate COGS Using the COGS Formula
Calculate the Cost of Goods Sold (COGS) by adding Net Purchases to the Beginning Inventory in a certain period, then subtracting it from the Ending Inventory for that period.
Here is the COGS formula:
Cost of Goods Sold (COGS) = Net Purchases + Beginning Inventory – Ending Inventory
Description of the COGS Calculation Formula:
Net Purchases are the total purchases of merchandise made by the company to buy goods in cash or on credit. Then, add direct costs such as freight costs.
Then, purchases are subtracted by purchase discounts and investment returns, giving you the net purchase value for a period.
Beginning merchandise inventory is available at the beginning of a company’s accounting period, for example, at the beginning of the month or the beginning of the year. You can check the initial inventory balance for this item in the trial balance for the current period or the trial balance at the company’s beginning in the previous year.
The ending Inventory of merchandise is the remaining Inventory at the end of a company’s accounting period, for example, at the end of the month or the end of the current accounting year.
You generally get this balance value from stock-taking or physical stock calculations (if the company has not used a stock or accounting application). Meanwhile, if the company already uses the stock application, all you have to do is check the remaining stock on the stock application.
Formula of Cost of Goods Sold (COGS) in Manufacturing Companies
The calculation of COGS in manufacturing companies is much more complicated than in trading companies. This is because in a trading company, you only buy and then sell the same goods, so there are not many costs arising from the goods purchased. Generally, only the freight.
While in manufacturing companies, there is a change in goods from raw material goods that go through the production process to finished goods. Therefore, the COGS formula for calculating the Cost of Goods Sold (COGS) in manufacturing companies is as follows:
Cost of Goods Sold (COGS) = Cost of Production + Beginning Stock of Finished Goods – Ending Stock of Finished Goods
Calculating Cost of Production
Cost of Production is the price obtained from the raw materials and production costs incurred to convert essential goods into finished goods.
1. Calculating the Raw Materials used
The following formula can calculate the raw materials used:
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 using the formula below:
Total Production Costs = Raw Materials Used + Direct Labor Costs + Production Overhead Costs.
3. Calculating Cost of Production
To calculate the Cost of Production, the following formula is needed:
Cost of Production = Total cost of production + Beginning Inventory of Goods in Production Process – Ending Inventory of Goods in Production Process.
Example of Calculating Cost of Goods Sold (COGS) in a Manufacturing Company
In this example, the company has the following inventory details:
- The supply of raw materials at the beginning of the year is IDR 300 million.
- Semi-finished goods (goods in the production process) of IDR 200 million.
- Inventories of finished goods ready to be sold amounted to IDR 500 million at the beginning of 2019.
The company purchased Rp.800 million of raw materials in the same year with a shipping cost of Rp.80 million. Labour and machine maintenance costs in 2019 amounted to IDR 150 million.
At the end of 2019, the remaining use of raw materials was IDR 200 million, the remaining inventories in the process were IDR 100 million, and the remaining finished goods that could be sold were IDR 300 million. What is the company’s Cost of Goods Sold (COGS)?
- Initial Inventory of Raw Materials = 300,000,000
- Initial Inventory of Goods in Production Process = 200,000,000
- Initial Finished Goods Inventory = 500,000,000
- Purchasing of Raw Materials = 800,000,000
- Shipping Fee = 80,000,0000
- Labor and Machine Maintenance Costs = 150,000,000
- End of raw material inventory = 200,000,000
- End of Goods in Production Process = 100,000,000
- End Finished Goods Inventory = 300,000,000
The HPP calculation for this case example must be calculated through 4 stages, as mentioned earlier, namely:
- 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
- Calculating the Total Cost of Production
Total Production Costs = Raw Materials used + Direct Labor Costs + Production Overhead Costs
Total production costs = 980,000,000 + 150,000,000
Total production costs = 1,130,000,000
- Calculating Cost of Production
Cost of Production = Total cost of production + Beginning Inventory of Goods in Production Process – Ending Inventory of Goods in Production Process
Cost of Production = 1,130,000,000 + 200,000,000 – 100,000,000
Cost of Production = 1,230,000,000
- Calculating Cost of Goods Sold
COGS = Cost of Production + Beginning Finished Goods – Ending Finished Goods
COGS = 1,150,000,000 + 500,000,000 – 300,000,000
COGS = 1,430,000,000
So, the COGS for this manufacturing company is IDR 1,430,000,000,-
Example of Calculating Cost of Goods Sold (COGS) at a Trading Company
In this example, we’re using a retail snack store that only buys and sells goods. Then, the shop owner wants to do his production for some snack items that are selling well. One of them is cassava cracker snacks. The goal is to get more profit and sell their products to other stores outside their stores.
Here’s the description:
A retail shop that sells snacks/snacks is completing its 2019 year-end financial statements and calculating the amount of inventory as shown in the following data:
- Initial Inventory of Goods in 2019 = Rp. 300,000,000,-
- New purchases during 2019 = Rp. 500,000,000,-
- 2019 Ending Goods Inventory = Rp. 200,000,000,-
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 retail snack store sold Rp. Six hundred million of its merchandise last year and left only items valued at Rp—100,000,000 on December 31, 2019.
This information will not only help store owners plan their purchases for next year but will help them evaluate costs.
Benefits of Calculating Cost of Goods Sold (COGS)
Cost of Goods Sold (COGS) can provide information about the sales margin for each product if classification is made for each product category. Thus, management can determine which products are the most profitable and generate the most money.
Even by using sales and inventory applications, inventory calculations will be carried out automatically when input is purchased for goods and the sale of goods.
Thus the final stock will constantly be updated in real-time, and of course, the cost of goods purchased will be calculated automatically by the system at any time. So you can find out the amount of stock, selling items, and even the profits you get before the end of the period or the end of the year.
In addition, calculating COGS allows you to determine the revenue per item, per item category, and the company’s total revenue. You can even choose how much capital you spend on the goods or services sold.
This way, you can be more alert and not just focus on trying to increase sales. However, you will know the cost of goods sold with certainty to minimize the risk of losses due to incorrectly determining the selling price.
Well, now you know how to correctly calculate the Cost of Goods Sold (COGS). Next, find out how to determine the selling price by reading the following article: How to Determine Cost of Goods Sold and Selling Price Easily.