What is Cost of Goods Sold (COGS)?
This post will cover how to prepare cost of goods sold budget. Cost of Goods Sold is not a scary word. These are your costs DIRECTLY involved in rendering your service or when producing your product. It is also called Cost of Sales.
It reduces your revenue so it is deducted from Gross Receipts to come up with the Gross Profit. Gross Profit is what remains of your revenue after deducting discounts, returns and allowances and cost of goods sold.
Less: Discounts, Returns and Allowances
NET SALESLess: Cost of Goods Sold
What is Included in Cost of Goods Sold?
Cost of Goods sold includes all costs incurred to provide the service or produce the product. So that includes your raw materials, direct labor, and direct overhead. Include also Storage costs directly related to your products. Add all these items to your Cost of Goods Sold Budget.
Raw materials are the items you use to create the product. For resold items, it is the price you pay to buy the goods. Whether wholesale or not. For a digital product produced, the software cost is part of your operating expenses. This is because you share the software with your business. For example, creating marketing collaterals for your business.
There is a way to allocate the cost of software to your products but not really practical to do. This is because you have to identify the proper allocation driver and track your usage. However, if you use a software only to produce a specific product, then consider it as part of COGS.
In the case of an online business providing services, the bulk of COGS comes from direct labor. It is the “price” of the time spent to provide and complete the service. Hence, this may include the salaries of those directly working on the services. However, their job description and actual work only pertain to the services rendered. Their time is not shared by your business and clients.
Lastly, identify and include other indirect costs incurred for the product or service. An example is the cost to get the product to the customers. The cost associated with the promotion of the service to customers is another example. For instance, Facebook Ads paid directly for the service or launch promotion. Merchant Fees are COGS items also. Your affiliate expenses are another.
How Can You Manage Cost of Goods Sold?
Cost of Goods Sold is a business expense. Thus, the higher your COGS is, the lower your income is. It is a reduction in your income. Thus, it is important for you to manage your COGS efficiently. See what drives your COGS up like your direct labor. Are there too many processes to complete the service or product? How do you make it efficient?
Are you paying more staff than needed because of a very elaborative and complicated process? Is there a system to improve operational efficiency? Can you do some on auto-pilot? For example, onboarding your client may take you too much time. In addition, you have to pay for a specific staff just to onboard clients. Then consider CRM software to facilitate the process. It may be less expensive.
It also helps to review your pricing. Maybe you are pricing too low to get more volume but not enough to cover all costs associated with the service.
Introduction to Budgeting and Forecasting
What’s the difference between budget and forecast? Why do you need a budget and a forecast? When to do a budget and a forecast?
Do you need help with your budget and forecast? Avail of my FinancialClarity services. I can help you organize your plan, convert your action plan into numbers, and review your numbers monthly.