What Is ‘Cost of Goods Sold’ and How Do You Calculate It?

Being a business owner comes with a wide range of benefits, but it will also come with a certain level of responsibility. One of your responsibilities will include paying attention to key performance indicators and other metrics that measure the success of your business. 

One of those essential KPIs is known as the “cost of goods sold.” Many business owners will grow accustomed to this term because it will be required on your tax return, so long as you sell a product. For those that are new business owners, the ‘cost of goods sold’ is likely something you’ve never had to calculate before. 

Although it’s a complicated process, we’ll break down the basics for you below and help you accurately calculate it for your own business. 

Explaining ‘Cost of Goods Sold’

‘Cost of goods sold’ is a calculation that will showcase the expenses involved in producing the products you sell. As you’re well aware, there will be various cost factors that will go into the production and selling of your product. ‘Cost of goods sold’ will take each of these factors into consideration.

The typical costs included in this calculation are material costs and direct labor costs. It won’t, however, include factors like sales, distribution, marketing, and overhead. 

Since the ‘cost of goods’ will be found on your tax return, it’s something you’ll have to get used to doing every year. This also means you’ll have to keep track of all the direct and indirect costs throughout the year. It will be viewed as a business expense since it’s essentially a cost of doing business. 

Calculating ‘Cost of Goods Sold’

In order to calculate ‘cost of goods sold,’ you’ll need three pieces of data — beginning inventory cost, additional inventory cost, and ending inventory cost. Let’s take a look at what each of these data represents:

1. Beginning Inventory Cost – this number will always be the ‘cost of goods sold’ that was recorded on your previous year’s tax return. It’s the value of the goods you have in your inventory at the beginning of the year.
2. Additional Inventory Cost – this number will represent how much you spent throughout the year on labor, materials, and other cost factors used in the ‘cost of goods sold’ calculation. 
3. Ending Inventory Cost – similar to the beginning inventory cost, this number will be the value of the goods in your inventory at the end of the year. Since these items have yet to be sold or even manufactured, they are viewed as an expense.

To calculate the ‘cost of goods sold,’ you’ll need to add the beginning and additional inventory costs, then subtract the ending inventory cost. See below:

Beginning Inventory Cost + Additional Inventory Cost – Ending Inventory Cost = Cost of Goods Sold

While the formula seems rather easy, the difficulty arises when trying to figure out which expenses can be factored into the costs. If you need any further assistance in calculating your ‘cost of goods sold,’ contact my office today!

References 

Murray, Jean. “Calculating Cost of Goods Sold – Step by Step.” The Balance Small Business, The Balance Small Business, 7 Nov. 2019, www.thebalancesmb.com/how-to-calculate-cost-of-goods-sold-397501.