It’s common for large companies to face problems with expense control, expenses, cost reduction, profitability, among other elements related to finances. The issue is that, depending on the severity, these problems may dictate the success of the business.

The good news is that there are ways to manage these issues without hurting the company’s progress. One of the indicators that may help is the COGS: a measure capable of providing essential information on the relationship between the sales and purchases of an enterprise.

In this article, you’ll understand how to calculate COGS and its importance to optimize strategic management. Check it out!

What are COGS?

COGS, also known as Cost of Goods Sold, is the relationship between sales and the expenses needed to produce and stock a particular good.

This financial indicator measures the success of a product by the amount of capital in stock. That way, it’s possible to consider what remains in the inventory in a given period of time, instead of identifying only the goods output index.

COGS is most commonly used in commerce. For industries, there is another indicator, the Cost of Services Sold, or COSS. In this case, the same logic is used; the only difference is in the factors included in the calculation.

What are the benefits of COGS?

The inclusion of COGS in the financial balance sheet of any company may bring very interesting benefits that will allow it to achieve the expected results and control its production. Here are a few:

Alerts to expense issues

Because COGS deals directly with inventory and production expenses, it can be a great ally to find out if the organization is not overspending with a product/operation or if certain items in the inventory have been on the shelf for a long time.

Helps the expense management

The results obtained from calculating the Cost of Goods Sold are part of the accounting expenses and should be included with the sales revenues. That way, COGS becomes an important instrument not only to indicate profitability, but also to help company managers analyze the purchases of materials and the sales of what they produce.

Finds out if the company is healthy

Many investors use COGS to find the business’s gross margin. Since they can analyze the percentage of revenues and how much is available to cover expenses, it’s easy to have an idea of how the company’s finances are.

Assists in sales initiatives

With the results obtained by COGS, the company has enough information to improve its planning and create strategies to stimulate the consumer to acquire its products. After all, it’s possible to find out which items take a long time to be sold, and thus, think of plans to pass on these idle products. For example, do special offers or provide specific discounts.

Improves inventory management

As the company is able to identify which are the best-selling products and which ones have been in stock the longest, it’s possible to define measures to analyze the space.

In other words, it’s possible to determine how this area can best be used, in addition to using another space with capacity aligned to the quantity of products.

How to balance COGS and COSS

After you’ve obtained your indicator data, you may reach the conclusion that profitability is below what is expected. To balance this measure and return to the desired range, some steps can be taken.

Studying supply improvements, always seeking to negotiate and control waste, for example, is a great way to reduce costs and balance these parameters.

Also having a rigid control of stock, meaning controlling everything that enters and leaves your firm, as well as returned products or returned raw materials, can increase the precision of your COGS and COSS measurements.

What is needed to calculate COGS?

One of the most important parts in accurately calculating COGS is to identify, count and classify the products that are in the inventory, that is, the data must always be updated. This activity is crucial for obtaining input and output control, as well as making customer orders always accessible.

The production’s or service’s raw materials represent another point that needs to be analyzed and cataloged. That way, with these updated data, the chances of getting a correct COGS result are 100%. In addition, the possibility of having a broad view of what is missing or remaining in the inventory is almost certain.

How to calculate COGS and COSS?

Now that you know what COGS is, its benefits, and how to balance it with COSS, understand how to calculate these indexes below.

How to calculate COGS

As already discussed, COGS aim to indicate the cost of sales in a given period, taking into account what remains in the inventory. For this purpose, the amounts that must be considered are:

  • Beginning Inventory (BI)
  • Purchases (P)
  • Ending Inventory (EI)

Thus the formula is: COGS = BI + P – EI.

For example, if your company has $5 thousand in stock at the beginning of the month, you bought $3 thousand and ended the month with $4 thousand in inventory, the calculation of the COGS is made in the following manner:

COGS = 5000 (BI) + 3000 (P) – 4000 (EI)

COGS = $4 thousand

Then you subtract this result from your revenues to obtain your gross profit for the month.

Once you’ve obtained the gross profit, you can determine the net profit by subtracting the other costs, such as taxes on revenues, telephone and internet bills, etc.

How to calculate COSS

In terms of the COSS, which calculates the cost of services provided, the values are:

  • Beginning Value of ongoing services (BV);
  • Labor directly related to services provided (L);
  • Direct costs related to services, like renting equipment (DCS);
  • Indirect costs related to services, such as electricity and repairing equipment (ICS);
  • Ending Value of ongoing services (EV).

Thus, the formula is as follows: COSS = BV + (L + DCS + ICS) – EV

As already discussed, COGS aim to indicate the cost of sales in a given period, taking into account what remains in the inventory. For this purpose, the amounts that must be considered are:

How to calculate COSS

Note! The operations for gross profit and net profit are the same as in the previous calculation.

What is the importance of these indicators?

Most often, turnover and acquisition costs are used to calculate sales profitability. The inventory or the services in progress are included in this calculation. This allows the manager to consider the unsold products and obtain effective data on the company’s gross profit. That way, there is a better direction on how to control the production, storage or acquisition operations.

From the information presented, it’s clear that both COGS and COSS are essential to understand the cost of sales of goods or products, as well as the exact gains, optimizing and improving business processes.

Because they are indispensable tools for any manager, there is a number of management software that does these calculations, avoiding the manual process and decreasing the chances of obtaining false information.

Did this article help you understand the importance of COGS and how to calculate it? Do you want to know other solutions and financial tips? Access our content on how to create and analyze KPIs correctly right now!