GLOSSARY

COGS: Cost of Goods Sold

What is Cost of Goods Sold, or COGS for short? It signifies the direct costs of producing the goods sold by a company. The cost of the raw materials and labor used directly to make the goods are typically included in this sum. Many businesses sell goods that they have bought or produced. When the goods are bought or produced, the costs associated with such goods are capitalized as part of inventory (or stock) of goods. These costs are treated as an expense in the period the business recognizes income from sale of the goods.

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What is the Cost of Goods Sold formula?

How do you calculate the cost of goods? The Costs of Goods Sold (COGS) represent the expenses involved into producing your goods over a certain period.

The COGS formula goes as follows: COGS = starting inventory + purchases – ending inventory.

What does the Cost of goods formula exclude? The key takeaway is that the cost of goods sold (COGS) accounts for all costs and outlays directly connected to the creation of goods. Indirect expenses like sales and marketing and overhead are not included in COGS. Gross profit and gross margin are determined by deducting COGS from revenues (sales).

Ultimately, determining costs requires keeping records of goods or materials purchased and factoring in any discounts on such purchase. In addition, if the goods are modified, the business must determine the costs incurred in modifying the goods. Such modification costs do include labor, supplies or additional material, supervision, quality control, and use of equipment. Principles for determining costs may be easily stated, but application in practice is often difficult due to a variety of considerations in the allocation of costs.

Cost of goods sold may also reflect adjustments. Among the potential adjustments are decline in value of the goods (i.e., lower market value than cost), obsolescence, damage, etc.

Key Takeaways

    • The COGS formula is: COGS = starting inventory + purchases – ending inventory.
    • The cost of goods sold (COGS) accounts for all costs and outlays directly connected to the creation of goods. Indirect expenses like sales and marketing and overhead are not included in COGS. Gross profit and gross margin are determined by deducting COGS from revenues (sales).

What’s the difference between operating expenses & COGS?

First, what are operating expenses? Operating expenses, also known as selling, general, and administrative expenses (SG&A), are the costs of doing business. They include rent and utilities, marketing and advertising, sales, accounting, management, and administrative salaries.

Cost of goods sold (COGS) and operating expenses are both expenses that businesses incur to run their operations; however, the expenses are broken out on the income statement. Operating expenses (OPEX) are costs that are not directly related to the creation of goods or services, in contrast to COGS.

SG&A (selling, general, and administrative expenses) are typically included separately under operational expenses. SG&A costs are expenses like overhead costs that are not directly related to a product. The following is a general list of some operating expenses:

  • Rent
  • Utilities
  • Office supplies
  • Legal costs
  • Sales and marketing
  • Payroll
  • Insurance costs

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What are some common mistakes made when calculating cost of goods sold?

When calculating the cost of goods sold (COGS), businesses must be mindful of a number of potential pitfalls. One common mistake is failing to account for shipping and logistics costs. If a company imports its goods, it will need to factor in the cost of shipping, customs, and other logistical expenses.

Another frequent error is forgetting to include the cost of returns in the COGS calculation. Any product that is returned by a customer must be taken out of inventory and factored into the COGS.

Finally, businesses must be careful to only include direct costs in the COGS calculation. Indirect costs such as overhead should be excluded. By avoiding these common mistakes, businesses can get a more accurate picture of their true COGS.

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