Unlike the cogs of a wheel, the COGS of an ecommerce business play a hugely significant role in the store’s profitability. Find out what is cost of goods sold, how to calculate cost of goods sold, and why you need to track them to remain profitable.
What is cost of goods sold
Cost of goods sold, simply known as COGS or cost of sales, are the direct costs incurred by a business to sell its products. It’s not just the cost of the item itself, but every production, material and labor expense associated with said product. However, COGS exclude indirect costs such as marketing, overheads and other operating expenses (OPEX).
If you’re unsure what is included in cost of goods sold, you need to ask yourself if that particular cost would have arisen had there been no sale of that product? For example, if you sell toys, would you still incur marketing costs even if no products are sold? You would, which is why marketing and sales costs fall under their own separate line item in an accounting income statement.
COGS vary based on your e commerce business model. For example, a dropshipper’s COGS include their product cost from their supplier but don’t include any shipping-related costs, as the supplier delivers directly to the end customer.
On the other hand, a warehousing ecommerce seller would need to include shipping costs from their supplier to their warehouse (or even to the home of a home-based seller), but not the shipping costs to the end customer, as this doesn’t form part of COGS.
COGS formula: How to calculate cost of goods sold
COGS are calculated using this accounting formula:
In the cost of goods sold formula, the beginning inventory is any leftover inventory from the previous accounting period. You’ll then add on the total cost of any inventory that you bought during the current period, and deduct the value of any unsold inventory left at the end of this period. The accounting period is not necessarily a year, and may even be a month or a quarter.
Example of cost of goods sold
Assuming an e-commerce business records its inventory on a calendar year basis, it would record beginning inventory on the 1st January and ending inventory on the 31st December.
If the business had a beginning inventory of $12,000, purchased another $7,000 worth of inventory throughout the year, and ended up with leftover inventory to the value of $3,000, this would be the formula to calculate this business’s COGS:
Cost of goods sold calculator
When it comes to calculating your store’s COGS, you could either use an accountant to help you calculate your COGS or you could do it yourself. If you’re unsure how to calculate cost of goods sold, you could outsource your COGS calculation to a professional or use an online tool to help you out. Whichever route you take, you’ll still need to understand how the COGS formula works so you can provide the right information to your financial representative. Calculating COGS is something you’re going to want to get 100% accurate, as any miscalculation can skew your profit calculation.
Being an online seller gives you the added advantage of having access to online tools to help you automate your COGS calculation. If you use a cost of goods sold calculator, you simply need to plug in the numbers and they’ll get automatically crunched for you.
Before you get to the calculation stage, you need to decide which of the following accounting method you’ll be using (an accountant can help you with this stage):
- FIFO cost of goods sold – this accounting method uses the cost of the products that were produced or purchased first from suppliers (first-in-first-out)
- LIFO cost of goods sold – with LIFO, COGS are calculated based on products that were produced or purchased from suppliers last (last-in-first-out).
- Weighted average – this method takes the total cost of goods divided by the number of units available and then multiplies this number by the actual number of units sold to get the average cost of goods sold.
Confused somewhat? Let’s use some example numbers to clear things up. Just say you sell toothbrushes and the cost of the first 5 toothbrushes that you purchase from your supplier cost you $2 each. Due to increased plastic costs, the next 2 toothbrushes you buy cost you $2.50. During the next period, you sell 4 toothbrushes. Using the FIFO cost of goods sold method, your COGS would be $8 ($2 x 4 = $8). If you use LIFO cost of goods sold, your COGS would be ($2.50 x 2) + ($2 x 2) = $9. If you went with the weighted average method, your calculation would be: ($15/7) x 4 =$8.50.
Cost of goods sold and profitability
It’s essential to keep track of COGS to ensure that you’re remaining profitable. Profits are calculated by deducting expenses from your revenue, so if you get your COGS calculation wrong, you’ll have an inaccurate profitability assessment.
This is the role COGS play in the gross profit calculation:
Gross Profit = Gross Revenue – COGS
And then net profits are calculated using this formula:
Net Profit = Revenue – COGS – Expenses
(which is essentially gross profit less all other expenses and taxes)
Get your COGS wrong, and your entire profit calculation will be wrong too.
If you’re not 100% confident about how to calculate cost of goods sold, you can automate and use BeProfit – Profit Tracker. The app collects your COGS and all other expenses to give you a full picture of your store’s profitability. You can easily upload all your products’ COGS into the BeProfit app by auto-syncing with your e-commerce platform, as a CSV file, or a quick and easy manual upload for a short product list.