Are you an entrepreneur who wants to sell products? If so, one key component of turning a profit is wrapped up in an often-misunderstood bookkeeping concept. Which concept? Cost of goods sold (COGS). What is the Cost of Goods Sold? How can you ensure accurate accounting? And why should you care? Here are a few important answers.
What Is the Cost of Goods Sold?
As its name implies, the Cost of Goods Sold (COGS) is how much it cost you as the business owner to produce what you sell. This number is essential for federal income tax and financial accounting purposes because it shows whether or not you're making a profit from your retail enterprise. It also reduces your taxable income.
In general, the formula to calculate this number for any period is to add the value of your beginning inventory plus the cost of what you added to it, then subtract what inventory you have left at the end of the period.
Why Is Cost of Goods Sold Important?
As mentioned, only an accurate understanding of what you put into your products tells you if you are making money on them. This is why the COGS formula includes much more than just the cost of raw materials.
Consider an entrepreneur who upcycles old furniture. The cost of buying the old furniture may be only a small portion of the overall cost of producing their goods. They also buy paint and sanding materials. They may need specific tools that must be repaired and maintained. They may need to pay a supplier to make a new part. They pay for the shipping to get goods to customers. And their online platform charges fees.
Unless the upcycle captures all these additional costs, they may have no idea if they made a real profit or how much it was. This is why COGS includes many things attributable to the production process: things like freight, the cost of running the physical location where manufacturing is done, labor and contractor costs related to production, fees, administration of production, and insurance.
Where Can You Learn More?
Are you calculating your COGS correctly? Many Americans underestimate these expenses, making it harder to get their small retail business growing and thriving. Get help with your calculation by meeting with a bookkeeping service in your state who specializes in retail enterprises. With their guidance and experience, you can find the most accurate numbers and start using them to boost your bottom line.
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