When you are doing business you need to have track on each and every cost involved in the production activity. For this there are various ways to know the costs incurred by any organization and profitability involved in this process. One of those ways is Cost of Goods sold and the variables included in it are explained here by FinanceShed, Lets understand.
What Is Cost Of Goods Sold (COGS)?
Cost of Goods Sold is referred to as cost of sales and other production costs of the products which are manufactured and sold by the company. COGS is also applicable to those business organizations which purchases products and resell the same with modification and without modification. The COGS is the expense to the company and reduce the profitability of the company. Basically Cost of goods sold is that expense done by the company to produce or acquire the products and sell the same and this costs are included in company’s income statement. You must also know about sky prices in the market nowadays.
Variables Included In COGS
As discussed earlier, Cost of goods sold includes the direct cost of producing the product or the acquisition price of goods resold and the direct labor costs incurred. Specifically, COGS includes:
- Cost of raw materials.
- Cost of storing the products.
- Direct Labor cost.
- Factory Overhead Expense.
COGS also includes costs such as freight charges, shipping charges, storage expense, cost of containers and other overhead costs directly attributable to the production. This also includes indirect costs such as distribution costs that are directly related to the company.
Cost Of Goods Sold Formula
To find Cost of Goods sold during any period under accounts, the given formula is used.
Cost of Goods Sold = Opening Inventory + Purchases during the Period – Closing Inventory
Here, the opening inventory includes the left over inventory in the previous financial year or period. Purchase during the period include all the costs of purchase or production and closing inventory includes left over from the current period. Generally COGS is calculated for a single financial year but it can also be calculated for any given period.
Analysis Of The Formula
COGS is subtracted from company’s revenues in order to get gross profit. Gross Profit is the measure to evaluate company’s profitability after the company have managed its labor and supplies in the production process. Cost of Goods sold helps analysts, investors, and most importantly the managers of the company for decision making. Major decisions such as to make or buy are take based on COGS.
If the COGS increases the income of company decreases. Thus companies always try to reduce COGS and increase profit. Cost of goods sold is the cost of acquiring or manufacturing the products and that includes costs which are directly attributable to production or acquisition and these are material, labor and overhead.
Limitations of Formula
Although this formula is much useful for determining cost of Goods Sold there are certain limitations of it such as:
- Allocating higher costs to inventory than actually incurred.
- Overvaluing Returns and discounts.
- Overstating or understating the value of inventory costs to adjust profit.