We’ve talked a lot about calculating the cost of goods and the accounting methods you can use to value inventory. If it costs you $100,000 to produce 50,000 widgets, your average cost is $2 per widget. You’ll add up the total costs to produce your goods and divide it by the number of units created in the period. This evens out costs and prevents price fluctuations.

The average cost method blends the production costs throughout the reporting period. Using LIFO will usually result in higher COGS values and lower ending inventory amounts. That means that the oldest products are the ones left in your warehouse when it’s financial reporting time. It assumes that the newest items produced (the last ones in) are the first ones sold (the first out) when a customer makes a purchase. That’s based on the assumption that newer raw materials and labor have higher costs than older ones. In general, FIFO will result in a lower COGS amount and a higher ending inventory value. That means that the stock remaining on your shelves at the end of the accounting period is the newest. The FIFO valuation method assumes that the oldest inventory (the first in) is sold first (the first out the door). Leave the family pup out of this discussion. First-In, First-Out (FIFO)įIFO shouldn’t be confused with Fido.

So how you value stock has a significant impact on your COGS and resulting gross profit.Īccounting principles/rules (i.e., GAAP) allow a few different methods for calculating inventory costs that we’ll discuss. COGS & InventoryĬalculating the cost of goods sold rests mainly on the cost of inventory. So what does that mean? Let’s dig just a little deeper. The basic COGS formula is: Beginning Inventory + Purchase - Ending Inventory = COGS Now that you know some of the costs included in COGS, you’re probably wondering, “So how do I calculate this number?” This sits on the balance sheet as inventory. Indirect labor costs (e.g., management and administrative salaries, cost of labor, etc.).

Shipping costs to get a product to the customer.Factory overhead (e.g., utilities, maintenance)īut some ordinary business expenses excluded from the COGS calculation are:.Parts used in production (e.g., screws, glue, paint).Direct labor costs (e.g., factory workers’ wages and payroll taxes).Some of the standard inputs for COGS are: This includes the variable direct costs (both the direct labor and the raw materials) and fixed costs like factory overhead.Īn easy way to think about COGS is to ask yourself, “Would I incur these costs if I didn’t make a product?” If the answer is no, then these expenses are included in your COGS calculations. What Is Included and Excluded in the Cost of Goods Sold? I know you’re thinking, “How does what I don’t sell (inventory) change the value of what I do sell (COGS)?” But stick around, and we’ll get into more detail about both of these so you can rest easier tonight. The short answer is that COGS are your production costs, and it’s important because it helps determine your company’s profits.Īnd I’d argue that COGS is more about inventory than sales. Have you ever laid in bed at night and had trouble falling asleep because you didn’t know the answer to “What is the cost of goods sold?”Įven if you’ve never lost sleep from COGS, all business owners should have an understanding of what it is and, more importantly, why it’s important.

Cogs cost of goods sold