Whether you’re a small e-commerce business owner or leveling up to take on the big-name competition, you need accurate cost information to protect your profits. Cost of goods sold (COGS, or cost of sales) is an important metric for various departments, like sales, inventory, and accounting.
As you scale up your business and explore new markets, increasing costs might weigh you down and hurt your cash flow. However, if you try to cut expenditures without using inventory data, you might damage your growth potential.
To control COGS without stunting your business growth, it’s a good idea to leverage an inventory management solution like Cin7, which lets you calculate COGS in real time as your business grows.
COGS is the total amount of money that your company spends directly on the products you’ve sold. It’s similar to the cost of goods manufactured (COGM), which accounts for the cost of sold and unsold products you produce.
So, what does the COGS include?
It includes direct costs tied to your cost of inventory like:
COGS excludes any indirect costs associated with selling goods, including:
To calculate COGS, you also need to know your beginning inventory and ending inventory.
Your beginning inventory is your inventory at the start of the accounting period, and your ending inventory is simply your stock left over at the end of the accounting period.
Here’s how direct costs, beginning inventory, and ending inventory fit into your COGS formula:
Beginning Inventory + Direct Costs – Ending Inventory
If you monitor your COGS as your business grows, you might notice that your COGS increases as your business processes become more complex.
Your accountants need COGS for your company’s income statement. Two common accounting methods related to COGS are first in, first out (FIFO) and last in, first out (LIFO).
However, COGS calculations are useful for more than just preparing financial statements and keeping the IRS happy.
For example, as you add more distribution channels, COGS can highlight inventory weak points, helping you to control business expenses without hurting your bottom line.
So what’s the best way to tie COGS into your inventory management approach?
It helps to use an inventory management solution like Cin7, which gives you accurate job costing and lets you continuously calculate COGS. This gives you a real-time snapshot of your company’s financial health and the data needed to make better purchasing decisions.
By leveraging Connected Inventory Performance from Cin7, you can save your accountants or bookkeepers time and effort tracking down your direct costs.
Before we take you through the four stages of business growth (Beyond Basics, Unifying Operations, Scaling Up, and Sustaining Success) and explain what COGS means for each one, let’s look at the COGS for a brand-new business.
Say you start a small business from your garage, making bespoke coffee tables using your woodworking expertise. You already own the equipment needed, so your only costs are materials like wood and varnish.
You might buy leftover wood from a local furniture factory’s production to reduce costs and purchase varnish on clearance from your local hardware store. Since you don’t pay yourself a wage, you have no direct labor costs. Instead, COGS is the wood and varnish used for each table.
If you start a viable business (not just selling to friends and relatives), you move on to the first growth stage for product businesses: Beyond Basics.
At this stage, your business has a solid customer base, but there is plenty of room for sales growth.
You’ll want to add new product lines, hire staff, and find an alternative to manual inventory processes. Plus, processes like manual data entry and reporting are starting to waste time and cause inventory inefficiency.
Let’s go back to your woodworking startup to see how exactly COGS fits into Beyond Basics.
Your business has picked up, and you’re producing tables at capacity since your garage only has one woodworking machine and limited storage space.
Through careful planning, you’ve managed to create a production schedule that efficiently uses your time and resources. Instead of long evenings spent woodworking, you have extra time for marketing and networking.
You’ve grown enough that the local furniture factory owner recognizes you as a competitor, so you need to find a new direct materials supplier for wood. Your COGS will likely change as you transition to buying wood on the open market.
On the open market, you have a much better choice of quality materials like wood, and you’re building strong relationships with suppliers.
You’ve started to better organize your workflow by using basic Excel sheets for order tracking, stock counts, and accounting tasks, but you’re struggling to connect everything together correctly and make money.
All this time spent on manual inventory admin means you can’t devote as much effort to production, so you hire a friend to help out with manufacturing tasks. It’s great to have help, but this new employee must be paid a part-time or full-time wage, which means your COGS takes a hit.
If you can keep your business operating without losing focus on any key processes, such as manufacturing and selling, you’ll move on to the next stage.
At this stage, businesses take on even more employees, increase product lines, and move into new sales channels. This is great for growth potential, but some new challenges affect COGS, such as:
So, how does COGS change during the Unifying Operations stage?
Let’s have a look through the lens of our woodworking startup example:
You’ve rented a retail storefront with a large workshop in the back, purchased new equipment, and hired more staff to help you assemble and ship your expanding product offerings (e.g., tables, chairs, and stools) to customers.
To fulfill expected orders for new sales channels, you’ve ramped up production, but you need to ensure you don’t overproduce and wipe out your profits.
Crunching the numbers on COGS manually, optimizing your production process, and looking for bulk discounts with suppliers can become a time-consuming task.
Instead of personally delivering furniture or using a costly courier, you might also contract a third-party logistics company to help.
With so many new processes, how do you truly unify your company’s head-spinning operations and ensure your COGS and other operating expenses are as low as possible?
Moving away from manual processes with inventory management software like Cin7 Core or Omni helps to:
While business growth is steady during Unifying Operations, it is just the foundation for your next business stage. In the Scaling Up stage, product businesses explore new partnership opportunities and continue to diversify their sales channels. However, these growth spurts add complexity and increase COGS with:
So, can your woodworking business rise to meet the challenge while controlling COGS?
You’ll need to continually run COGS, inventory, and sales reports to ensure you’re operating at a profit. By getting rapid COGS calculations from your inventory management software, you can:
If you can comfortably scale up and use every resource at your disposal to maintain momentum, you’ll be able to shift your strategy in your next growth stage.
At this stage, businesses are making money and have reached a period of stability. Some key concerns in this new stage are:
In order to maintain the Sustaining Success stage, you must maintain a strong awareness of COGS.
If you continually monitor your COGS using inventory management software, you’ll be able to make small but decisive changes and keep your business in good financial health.
With Cin7’s advanced reporting and analytics feature, which includes 100+ customizable reports, you can bring together inventory and sales data to find out what your COGS means for your business at every stage.
In addition to inventory cost accuracy and seamless integrations, Cin7 automates every part of your inventory life cycle, helping you avoid manual COGS calculations and break free from your inventory shackles.
This way, you can stay focused on overcoming the various challenges of transitioning through different business stages.
Sign up for a free trial today to see how Connected Inventory Performance can help you clear your inventory to-do list and get back to growing your business.
