What is Cost of Goods Sold?
Cost of goods sold or COGS refers to the direct cost that a company pays in order to produce goods or services. The total COGS includes direct expenses such as labour, raw materials and indirect expenses such as distribution cost and sale force cost.
In order to calculate the gross profit of any company, the COGS is subtracted from the company’s revenue. It is important for the investors, owners, analysts and managers to understand COGS and try to cut it down as much as possible since it is an expense.
COGS has a direct impact on the net income generated. If COGS increases, the net income decreases and vice versa.
Components of COGS
- Labour: It includes the wages and salaries of people involved in the production of goods and services. Since it is an expense it is counted in COGS.
- Raw materials: The total cost of raw materials incurred in order to produce the end product is a major component of COGS. The higher your raw material cost, higher will be your COGS.
- Manufacturing Overhead: Indirect costs related to production, such as utilities, depreciation of manufacturing equipment, and factory rent. These costs support the production process but cannot be directly traced to specific units of production.
Calculation of COGS
Formula for COGS:
COGS=Beginning Inventory+Purchases−Ending Inventory
- Beginning Inventory: The value of inventory at the start of the accounting period.
- Purchases: The cost of additional inventory acquired during the period.
- Ending Inventory: The value of inventory remaining at the end of the period.
COGS Example
Let’s assume that a company starts the year with an inventory of ₹50,000. During the year, the company purchases additional inventory worth ₹120,000. By the end of the year, the ending inventory is valued at ₹40,000. Let us calculate the COGS:
COGS= Beginning Inventory + Purchases − Ending Inventory
COGS= 50,000 + 1,20,000 + 40,000
COGS= Rs. 1,30,000
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