What is the Cost of Goods Sold?
The immediate cost to produce any goods or services is referred to as the cost of goods sold (COGS). The cost of labor and material directly used to create that product is included in the amount. It refers to the funds the business directly spends on producing a specific product.
What is the Significance of the Cost of Goods Sold in an E-commerce Business?
The cost of goods sold is significant to businesses because it includes all the direct costs related to production. Companies deduct the value of COGS from the total revenue it generates to see how much profit the product makes and overall the profit margins. If the COGS is too high, the profit margins will be lower, and the business will have to rethink its production costs.
Significantly, COGS does not include the cost of items in the inventory during the period. It is only used on the return profits of the items sold to determine whether the product line is doing well in the market. Investors and management alike can monitor the performance of products in the market through COGS.
How to Calculate COGS and What are the Prerequisites of It?
Formula to calculate COGS:
Cost of Goods Sold = (Beginning Inventory + Cost of Goods) – Ending Inventory.
– the beginning inventory refers to the leftover inventory from the previous year.
– the cost of goods is the price of any items purchased or made in the year.
– Lastly, ending inventory is the leftover inventory that will become the beginning inventory next year.
Some other points to note are-
- The value of COGS also depends on which of the three standard methods of inventory costing the business uses. LIFO, FIFO, and Average Cost Methods measure how much inventory is sold during a specific period.
- Indirect costs such as marketing, salary, and other overhead costs are not counted in COGS. It only includes the direct costs of production.
Use Case with Cost of Goods Sold
For example, if a company sees that its COGS is pretty high, but the profit margin is suffering because the product is not doing very well in the market, it might choose to shut down that line of products and focus on more successful ones.