The FIFO method sells the oldest inventory first. Here are some of the most commonly used methods: First In, First Out (FIFO) Your tax agent or accountant should advise you on the valuation method to use for your business. COGS accounting methodsĬalculating COGS requires choosing an appropriate inventory valuation method. Knowing your COGS helps lenders and investors accurately assess your business's potential and profitability. Thus, investors consider it when deciding whether to invest in you (and how much to invest). Attract investment opportunitiesĬOGS is a significant business expense that affects your bottom line. Calculating your COGS gives you valuable insight into how much you’re spending on your inventory so you can adjust your pricing accordingly. Your business may generate a lot of revenue, but if your COGS is too high, you won't make much profit. For example, if your COGS increases, you might consider reducing production costs or raising your prices to maintain profitability. Keeping up-to-date on your COGS can help you make better business decisions. If you want to be successful, you have to be profitable, and you can only calculate gross profit margins if you know what you spend on producing each item. Identifying your COGS is essential to assessing your company's financial health. The importance of COGS for businesses Understand your financial health Indirect costs support product production more broadly, such as factory overheads, storage costs and the cost of using equipment (depreciation). There are two distinct categories of Cost of Goods Sold: Direct costsĭirect costs are those directly linked to the making of a product, including freight-in costs, cost of materials and labour costs. Operations costs, like depreciation of hardware and software that support production, as well as factory overheads.

Labour, including shipping parts to the warehouse and salaries for production workers.

Materials, such as products or parts needed to assemble products, or items purchased for resale. Here are some of the most common COGS items: A restaurant, on the other hand, calculates COGS using food, labour and overhead costs. For example, an ecommerce store may consider the cost of wholesale products, inventory storage and website expenses when determining COGS. Your industry and product type determine what you include in COGS calculations. However, the requirements for calculating this are the same.īoth types of companies must report the “cost of goods sold” or the “cost of sales” in their financial statements. Companies that sell services, such as accounting firms, lawyers or consultants tend to calculate the cost of sales as they don’t sell goods. Your business type determines the type of costs you'll incur.Ĭompanies that sell tangible products, like t-shirts, building materials or food, will calculate the cost of goods sold. Not all businesses calculate COGS - some companies refer to cost of sales instead. Financial and income statements usually list COGS according to the accounting period they cover. It includes the costs of the materials, storage and manufacturing labour, but not indirect costs such as distribution, marketing and management salaries.ĬOGS is considered a business expense and impacts your profit - the higher your COGS, the lower your profit margin. Cost of Goods Sold (COGS) is the term used to describe the direct costs of manufacturing a product.

Cogs an expense account