Cost of Goods Sold
The Cost of Goods Sold (COGS) is the direct costs associated with producing goods that a company sells. COGS is an important figure because it is subtracted from a company’s revenues to determine its gross profit.
COGS includes the cost of the materials used in creating the goods being sold by the company along with the direct labor costs used to produce the goods. It excludes indirect expenses such as distribution costs and sales force costs.
COGS is calculated using the following formula:
COGS = Beginning Inventory + Purchases During the Period – Ending Inventory
Where:
- Beginning Inventory: This is the inventory that a company has on hand at the beginning of the fiscal year.
- Purchases During the Period: This is the inventory that a company purchases during the fiscal year.
- Ending Inventory: This is the inventory that a company has on hand at the end of the fiscal year.
The formula shows that if a company purchases more goods or materials during the year than it sells, its COGS will decrease, leading to a higher gross profit. Conversely, if a company sells more goods or materials than it purchases, its COGS will increase, leading to a lower gross profit.
Example of Cost of Goods Sold
Let’s consider a hypothetical example to illustrate the calculation of Cost of Goods Sold (COGS):
Suppose we have a company that manufactures furniture. Here are the relevant figures for one fiscal year:
- Beginning Inventory: $1,000,000 (This is the value of the inventory at the start of the year.)
- Purchases During the Period: $500,000 (This is the value of additional raw materials purchased during the year.)
- Ending Inventory: $300,000 (This is the value of the inventory remaining at the end of the year.)
We can use these numbers to calculate COGS as follows:
COGS = Beginning Inventory + Purchases During the Period – Ending Inventory COGS = $1,000,000 (Beginning Inventory) + $500,000 (Purchases) – $300,000 (Ending Inventory) COGS = $1,200,000
So, the Cost of Goods Sold for the company during this fiscal year is $1,200,000. This means that it cost the company $1,200,000 to produce all the goods it sold during this year. This figure would then be used to calculate the company’s gross profit by subtracting COGS from the company’s revenues.
