Large companies often face difficulties in controlling costs and spending, reducing costs, profitability and other elements of this type, which end up dictating the success of their businesses.
This is why one of the most important indicators is COGS, which makes it possible to identify essential information in terms of the relationship between your company’s sales and purchases.
In this article, you’ll understand what this parameter means, how to balance it, and its importance in the optimization of your strategic management!
In addition, you’ll be able to follow step by step how to calculate it in a simple and practical manner.
The Cost of Goods Sold is the relationship between the sales and expenses necessary to produce and store a given piece of merchandise.
COGS is an indicator that measures the success of a product in a different way: the calculation is based on the value of your inventory capital, because having a large amount of products shipped does not guarantee good profitability, because what remains in storage during a given period must also be considered.
This parameter is heavily used in commerce. For service industries, there is an indicator that uses the same logic, but just changes the factors used in the calculation: the Cost of Services (COS).
The importance of these parameters
Generally, revenues and purchasing costs are used to calculate the profitability of sales.
Including inventory in this calculation — or ongoing services —, makes it possible for the manager to consider the products that haven’t been sold and obtain effective data about the company’s gross profits.
This will provide better guidance in terms of controlling production, storage and purchasing operations.
How to balance COGS and COS
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 COS measurements.
Step by Step Calculation of the Indicators
As we’ve said, COGS is designed to indicate the cost of sales for a given period, considering what is still in stock.
Thus, the values to 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.
In terms of the COS, 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: COS = BV + (L + DCS + ICS) – EV
The operations in terms of gross profit and net profit are the same as for the previous calculation.
Thus, it’s clear that COGS and COS are fundamental to understanding the cost of goods sold as well as exact gains, and they will help you optimize your company’s processes.
Since this is an indispensible tool for any manager, there is management software that will perform these calculations, which will avoid manual calculations and thus decrease your chances of obtaining incorrect information.