Cost of goods sold (COGS) is the total cost directly incurred by a company to sell its goods or services. In manufacturing, the cost of goods sold is also known as the cost of goods manufactured (COGM). Manufacturing companies need to do COGS Calculations to find out the exact selling price of goods. Calculating costs and doing bookkeeping can be easier to manage with the help of a comprehensive accounting system. This system is suitable for many industries, including manufacturing. Therefore, many manufacturers are now implementing accounting software.
In general, the COGS includes raw material costs, labor costs, and overhead. Cash flow management in the company can be optimized using the right accounting application. Moreover, automating financial processes with this application can really help with many aspects, including calculating costs. The best accounting system is the right solution for this. Additionally, you can find out more about the accounting software pricing scheme calculation beforehand.
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The Basic Components of COGS Calculation
To get an 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 purpose of this inventory is to calculate the amount of inventory that has been sold in one period. Manufacturers can determine the balance of the beginning inventory costs from the current account balance, the company’s initial balance sheet, or the previous year’s balance sheet.
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. Manufacturers can figure out the balance of the ending inventory costs from the adjustment report at the end of the period. Subtract the number of products ready for sale from the starting merchandise inventory plus net purchases to get the ending merchandise inventory.
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. There are five elements of net purchases that you need to pay attention to such as purchase freight costs, gross purchases, purchase discounts, purchase returns, and price reductions.
Ensure efficient procurement costs, manage purchase requests across multiple branches, seamlessly place orders with multiple suppliers and get the best deals with the best purchasing system. Moreover, if you’re interested in implementing purchasing system, you can download the pricing scheme calculations first.
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 they will use much quantity of raw materials to produce an item.
Here is how to calculate all the raw materials used in production:
Raw materials used = initial balance of raw materials + raw material purchases – the 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 when the goods are entered into the production process and the cost to produce these items. To determine the total cost of production, raw materials for goods at the beginning of the production period must be added to non-basic raw materials (e.g., direct labor and overhead). The company will subtract the goods remaining in the warehouse at the end of the period.
Calculate the Cost of Goods Sold
Now it’s 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 – the final balance of finished goods
Once you calculate the cost of the original items, you can calculate the gross income of your business. 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
Calculating COGS manually is quite a hassle because it usually requires a lot of documents to record each component. In addition, manual COGS calculations are also prone to errors.
You can make the COGS calculation 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. Therefore, manufacturers can monitor all their financial data anytime and anywhere through a single system. Schedule a free demo now to experience the transformational power it brings to your operations.