What is cost of goods sold, and how does it affect your business? Your business generates revenue by producing a product or selling a service. The cost of making these products or services is the cost of goods sold.
Let’s look closer at how we calculate cost of goods sold and how you can use it to manage your business.
What Is Cost of Goods Sold?
Cost of goods sold is the total cost of creating or producing a product or service. It includes the costs of materials, storage, and shipping. It also includes indirect overhead costs, such as labor, cost of management and supervisors, and utility expenses for warehouses, facilities, and equipment.
In a service business, such as an accounting firm, the cost of goods sold includes labor, employee benefits, and payroll taxes. At a retail business, such as a clothing or jewelry store, the cost of goods sold includes the cost of buying or making merchandise.
You can find your cost of goods on your business’s income statement. Subtract it from your revenues to find your gross profit.
How to Calculate Cost of Goods Sold
The simplest way to calculate cost of goods sold is to use this formula:
Cost of Goods Sold = Beginning Inventory + Purchases − Ending Inventory
If you’re calculating the cost of goods sold in a year, add your inventory value at the beginning of the year and any purchases — including materials, labor and indirect overhead expenses — made during the year. Then subtract your inventory value at the end of the year.
Why Is Cost of Goods Sold Important?
Your cost of goods sold factors into the gross profit your company earns. Your gross profit must be enough to cover overhead expenses, interest costs and taxes and still leave a reasonable net profit.
Monitor your cost of goods sold to see how efficiently your business uses its labor and materials. If you’re spending too much to create your product, you won’t make enough to turn a net profit. This could mean you need to reduce material costs or improve productivity.