In Pursuit of Profit
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Despite its importance, many e-commerce solutions do not track COGS for business owners, which means you need to stay on top of it yourself. Using accounting software is an excellent way to track and manage COGS across product lines and the overall business.
COGS is tied to virtually every aspect of a business, so getting it wrong can have serious implications. A miscalculated COGS can negatively affect pricing, marketing strategy, purchasing, forecasting, and cash flow management. It can also result in an incorrect taxable income, resulting in fines and penalties, as well as increasing your chances of being audited.
If COGS is one of the most valuable metrics for retail businesses, the gross margin is typically considered the most critical parameter. Since COGS is a component of the gross margin formula (Gross Margin= Sales – COGS), it plays a part in this essential figure as well. Therefore, if COGS is wrong, it will also affect other critical key performance indicators (KPIs) up the chain as well.
How to Calculate COGS
COGS = Beginning Inventory + (Purchase Costs + Labor Costs + Materials Costs + Supplies Costs + Miscellaneous Costs) - Ending Inventory
Calculating COGS should be done at the SKU level to provide more granular information. Doing so will arm you with more precise information to enable better decision-making related to individual products and available options. Of course, determining COGS for individual products requires an accounting software that can handle large datasets of cost inputs across all available product option configurations.
To get started, figure out your initial inventory, then define your product-related direct and indirect costs, add inventory purchases, and perform an inventory county to confirm ending inventory. Use these inputs to calculate COGS over a defined reporting period.
On the surface, calculating COGS sounds simple – just add up all your costs, right? Well, not exactly. There are some business costs (like marketing expenses) that do not get added to COGS for any business type. Then, to complicate matters, there are some costs associated with doing business online that e-commerce companies must remember to include, like shipping costs.
Think about it this way; everything that is used to create/build/assemble, package, and ship the product should be included in COGS. This includes your materials, labor, and operations involved in making products, either directly or indirectly.
COGS includes direct costs related to the purchase of products such as:
As well as indirect costs related to the facilities, labor, and equipment needed to sell products such as:
Some indirect costs like facilities costs are exceptionally complicated to calculate because a portion of each expense must be spread out across all units produced. Lean on an experienced accountant to help in this area and invest in the right software to be able to handle your ongoing cost calculation needs.
Need to find accounting software to assist with COGS calculations? Read our article comparing traditional accounting software with cloud-based accounting software to find the right solution for your e-commerce business.