Cost of Goods Sold vs. Cost of Sales Calculation for Businesses
There are various supply chain expenses that businesses handle in order to provide customers with their merchandise. By measuring how these costs compare to sales, companies can effectively monitor their financial health.
The cost of sales and cost of goods sold are standard inventory accounting metrics that consider the various expenses a business incurs. Through simple calculations, organizations can determine if their stock costs surpass their revenue, hindering net profits. However, these two values consider different types of expenses that apply to specific businesses, making it crucial to differentiate.
Cost of Sales vs. Cost of Goods Sold
When making investments, businesses need to analyze their expense and income reports, particularly the cost of sales (CoS) and the cost of goods sold (CoGS). Therefore, businesses need to be able to differentiate between these two financial elements to ensure they are making educated financial and inventory management decisions.
The key differences between the cost of sales and cost of goods sold are-
- Analyzing the CoGS is an evaluation of the operational costs required to produce the items, disregarding any indirect expenses. CoGS considers the changes in stock and how well the business can convert inventory into cash flow. On the other hand, CoS evaluates both indirect and direct expenses related to the sale of products.
- Since CoS considers all expenses, it will always be greater than CoGS.
- CoS is part of a company's income statement before the EBIT margin (also known as the operating margin), whereas the CoGS is presented after the revenue.
- Companies that handle merchandise or services, from manufacturing to trading goods, use CoGS. However, CoS encompasses many types of industries and is used in accounting by every organization.
- CoS is not standardized within an industry, therefore businesses will find inconsistent cost metrics. On the other hand, CoGS are typically similar as they are directly proportional to the production of goods.
- While businesses can claim CoGS, CoS is not tax-deductible.
- CoS is calculated using the goods a company has sold within a time frame, while CoGS uses the total amount of goods manufactured.
Given the key differences, service-only businesses use CoS as they are not directly involved or invested in the production process. These companies typically include retailers, lawyers, painters, financial consultants, and doctors.
On the other hand, manufacturing companies that can claim operating expenses use CoGS. However, service providers that offer secondary products can claim CoGS as well as CoS. This includes hotels that provide services as well as merchandise and airlines that sell food and beverages.
How to Calculate the Cost of Goods Sold
Given that the COGS depends on how much a business has invested in producing and trading goods, the calculation will vary from company to company. The basic formula is-
COGS = Beginning Inventory + Purchases Ending Inventory
In this calculation, the beginning inventory refers to the stock left over from the previous year that has rolled over into the new fiscal year. Additional purchases made throughout the following sales period are then added to the beginning inventory.
At the end of the year, any items that were not sold, known as ending inventory, are counted and subtracted from the beginning inventory and other stock expenses. Since the ending inventory refers to the year's left-over stock, it rolls over and becomes the next year's beginning stock.
This formula calculates the material costs, which is different for every organization involved in the supply chain phases. For retailers, material costs refer to purchasing merchandise for resale. On the other hand, manufacturers must consider the cost of raw materials, components, and other direct expenses required to assemble products.
It is crucial to account for any supplier discounts or returns the company obtained by altering the formula-
COGS = Beginning Inventory + Purchases Discounts Returns Ending Inventory
For example, let's consider a clothing retailer-
Beginning Inventory- $70,000
Supplier Discounts- $1,700
Ending Inventory- $62,000
To calculate the retailer's COGS, they would need to use the altered formula that considers discount and returns-
$70,000 + $55,000 - $1,7000 - $900 - $62,000 = $60,400
Therefore, the retailer's total COGS is $60,440.
However, the COGS formula would look slightly different for the manufacturer who produced the clothing, as they handle different types of expenses-
Beginning Inventory of Raw Materials- $85,000
Ending Inventory- $68,000
$85,000 + $75,000 - $68,000 = $92,000
The manufacturer has a higher COGS at $92,000, as they handle several expenses to source the various raw materials and components for their items.
The COGS value is important inventory data that represents a company's financial stability. Once the COGS is calculated, it is subtracted from the revenue to determine the gross profits. Therefore, if the expenses are significantly lower than the generated revenue, the organization is profitable and can maintain a healthy bottom line. On the other hand, if the COGS outweighs the sales, the business may be at risk of bankruptcy.
COGS and COS are essential measurements for businesses to monitor as they represent different financial health elements, such as profitability, stock turnover, and inventory control. By differentiating the two metrics, companies can determine which expenses to minimize to boost the bottom line.
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