Cost of goods sold (COGS) is the total cost directly incurred by a company to sell their goods or services. In manufacturing, the cost of goods sold is also known as the cost of goods manufactured (COGM).
COGS calculations are conducted to determine the amount of production costs that will be incurred by the company when producing goods. In general, the COGS includes raw material costs, labor costs, and overhead costs.
Check out the following easy tips to find out how to calculate COGS in manufacturing companies!
The Basic Components of COGS Calculation
To get the accurate COGS calculation, you need to know the three basic components that determine it. The three components are:
Beginning Inventory Costs (at the beginning of the year)
The beginning inventory costs are all the inventory costs at the beginning of the period or the current financial year. The balance of the beginning inventory costs can be figured out from the current account balance, or the company’s initial balance sheet, or the balance sheet of the previous year.
Ending Inventory Costs (at the end of the year)
The ending inventory costs are all the inventory costs at the end of the period or the end of the current financial year. The balance of the ending inventory costs can be figured out from the adjustment report at the end of the period.
Inventory purchases include all raw material purchases made by the company, both cash and credit transactions. They also include the cost of transportation minus discounts and returns.
How to Calculate COGS
The COGS calculation method in manufacturing companies is slightly different from that of in service and retail companies. Here are the steps to calculate it:
Calculate the Raw Materials Used
Since manufacturers produce their own merchandise, they need raw materials. Basically, raw materials are the main requirement for calculating the cost of goods sold.
Manufacturers must determine how much quantity of raw materials will be used to produce an item. To determine that, they will need to find out how much the quantity of raw materials are left at the end of the period after the initial balance of the period added to the purchases during that period.
Here is how to calculate all the raw materials used in production:
Raw materials used = initial balance of raw materials + raw material purchases – final balance of raw materials
Calculate the Additional Production Costs
In addition to the main raw materials, there are other costs that affect the production process of goods, from raw materials to finished goods. These costs include:
- Direct labor costs.
- Overhead costs (non-basic raw material costs) such as electricity costs, maintenance costs, reparation costs, and so on.
Calculate the Total Production Cost
The total production cost includes costs incurred when the goods are entered into the production process and costs incurred to produce these items. To determine the total cost of production, the raw materials of goods processed at the beginning of the production period must be added to non-basic raw materials (e.g. direct labor and overhead), then deducted by the items remaining in the warehouse at the end of the period.
Calculate the Cost of Goods Sold
Now it’s the time for us to calculate the COGS. All you have to do is add the finished goods produced in the warehouse at the beginning of the period with the production cost of the current period, then reduce the finished goods remaining in the warehouse at the end of the period.
Here is the formula:
Cost of Goods Sold = Initial balance of finished goods + production completed in the current period – final balance of finished goods
After the cost of goods sold is calculated, you can calculate your business’s gross income. It is the amount of money that your business gets from sales before deducting taxes and other expenses.
Read the related article: The Importance of Accounting Software for Businesses
How to Calculate the Cost of Goods Sold Instantly
Calculating COGS manually is quite a hassle, because usually it requires a lot of documents to record each component. Separate paper documents or spreadsheets often get misplaced, damaged, or even lost. In addition, manual COGS calculations are also prone to errors.
The COGS calculation can be made a lot simpler and easier with the help of an online accounting system. With HashMicro’s cloud-based accounting system, you can calculate the COGS accurately in just seconds. All your financial data can be monitored anytime and anywhere through a single system.
Click here for more information about EQUIP Accounting Software by HashMicro.