What is Cost of Goods Sold?

Cost of Goods Sold
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The Cost of Goods Sold or COGS for short, is as it sounds; it is the cost of the inventory you bought to be sold to a customer. This calculation includes all of the costs associated with the sale of the product including freight. It does not include any expenses associated with selling the merchandise like payroll or rent. Knowing your Cost of Goods Sold can be a great tool in running your retail business, especially when you can compare your COGS to other retail stores in your same industry.

 

It is calculated as:

Beginning Inventory + Cost of Goods Purchased - Ending Inventory = COGS

Let's say you own a shoe store. At the end of the month, you want to see what your Cost of Goods Sold was for that period. If you had $100,000 worth of shoes at the beginning of the month and you bought $10,000 worth of shoes during the month and you had $50,000 worth of shoes at the end of the month, then your COGS would be $60,000. ($100,000 + $10,000 - $50,000 = $60,000) 

If you buy a shoe for $50 from a vendor and it costs you $5 to have it shipped to you (freight,) on your books (commonly referred to as your income statement or P&L) you have $55 for COGS. If the next time you order the shoe the vendor has increased the price, then the new shoe will be $55 plus $5 in shipping for a total of $60. You do not change the price of the shoe you already have in stock. COGS does not change on an item once it enters the store.

 

However, depending on the inventory accounting method your accountant is using, he or she may be able to chart which COGS to use when the item is sold. There are two main types of inventory calculation methods - FIFO and LIFO. 

FIFO or “First-In, First-Out” assumes that the oldest units of inventory are always sold first.

 

LIFO or  “Last-In, First-Out” assumes the opposite - that the last one to come in is the first one to go out. For more info on these methods, read this article

Properly managing inventory is the key to successful retailing. Too much inventory can leave you with cash flow problems and too little inventory can leave you with sales or revenue problems. it is an incredible balancing act that is equal parts of art and science. One of the best tools you can use to manage inventory is an open-to-buy system. This process helps you buy only the merchandise you need. It uses COGS and inventory turns to determine how much more inventory you need compared to what your sales trends have been. 

Another key metric to monitor in retail is gross margin. Since you now know the COGS, you can figure the gross margin.

Total Sales - COGS = Margin

For example, if you sold $100,000 worth of shoes during the same month you calculated above for COGS you would subtract your COGS of $60,000 to determine your gross margin of $40,000. Gross margin can be expressed as a dollar amount or a %, but the % is the most common way to review and analyze gross margin. (Here is a great article to help you with gross margin.)