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.
It is easy
Another positive point of COGS is the simplicity of the calculation, which reveals valuable information for your business. After all, if your company has the accounting data and information up-to-date, it will be possible to know if there are superfluous expenses or investments beyond what is indicated in some operations.
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
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.
How to control the inventory to calculate COGS?
As you can see, the information of what comes in and out of your stock is part of the COGS calculation, and it is very important to keep this sector organized and up-to-date. There are two ways to control your product inventory efficiently. See below what they are and learn more.
First In, First Out (FIFO) is an assessment and way of controlling your inventory based on the assumption that the products that arrived first must be removed first. That is, the oldest batch is used, and the price will take into account the cost of when it was acquired, not when it was sold.
In order for this control to work efficiently, as the items are removed from stock, the people responsible should record that activity, however small it may be. This is essential because, the greater the accuracy of records, the better the control and knowledge of their demand will be.
Last In, First Out (LIFO) is an inventory control method based on the theory that the last items that arrived in your stock will be sold.
To that end, the sales price is practiced according to the last batch that arrived at the warehouse, and the stock value is calculated based on the cost of the last price; therefore, it is usually more expensive.
For this reason, it is a method that leads to the overvaluation of an item, resulting in positive credits. It is important to emphasize that the LIFO method is not legal in Brazil. In other countries, such as Mexico, the United States and Germany, for example, it is a widely used and legally accepted method.
How can technology help?
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.
In addition, the management routine of a business is bogged down with information that comes in and out at all times, making it difficult to control, track, and efficiently process data. In this scenario, the successful implementation of technology is not only an aid, but a necessity to enter all kinds of information, in a fast and reliable way.
After all, in order for COGS to be as faithful as possible to the reality of your company, it is imperative to use updated values. Given this, in addition to management software, which assists in performing the calculations, ERP systems register all data in all sectors in an integrated way, including stock inwards and outwards.
That way, there will be less work and more efficiency in controlling not only your inventory, but the other departments of your business. In a highly competitive market, technology is a distinguishing factor, so be sure to make that investment.
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 now our content on how to correctly create and analyze KPIs!