How to Calculate Your Cost of Goods Sold (COGS)

What is COGS?

Your cost of goods sold (COGS) is the actual cost to physically produce your company’s product or service. How you calculate this number will vary depending on your solution and whether you consider it a product or service. The features and functionality of your solution will also impact the individual expenses that you include in your COGS calculation. For example, if you remanufacture toner cartridges, the costs for raw materials used in the production process, facilities and labour should all be considered key components of your COGS.

Determining the cost to produce and/or deliver your solution can get tricky if you use other service providers or outsource parts of the production process. You will need to account for these expenses in addition to the cost of any in-house work. For example, if you’ve partnered with an MPS provider and use their remote monitoring tool to power your automated supplies fulfillment program, you should include the cost of this solution in your COGS as it is an essential part of your solution.

The individual line items included in your COGS will depend on your business and whether you are calculating the cost for a product or a service, but may include:

• Raw materials
  • Are you manufacturing any hardware or consumables? If so, consider the price of the raw materials and any ancillary fees such as shipping or delivery of these materials.
• Labour to produce the product or service
  • What constitutes ‘labour’ will depend on your solution, but it may include any internal manufacturing or software development costs.
• Materials to deliver your product or service
  • Are you using any outsourced tools or resources such a remote device monitoring tool or cloud-computing platform (e.g. Amazon Web Services)? If so, these should be included in your calculation.
• Production facilities
  • Is this facility used solely for this product? If not, you can use a percentage based on utilized space.
• General overhead
  • Some companies include a cost for general overhead.

Note: Your COGS should only include direct costs that can be attributed to the production of your solution. Post-production costs like sales, marketing and distribution should not be included in your cost.

To calculate an accurate COGS, you should also have two other pieces of information: a period of time for your calculation and how many products sold or services delivered in this timeframe. You can then use these numbers to determine cost on a per-unit basis.

The Value of COGS

The cost to produce your solution is a valuable piece of information that, when used effectively, can help you achieve your business objectives, particularly when it comes to your pricing strategy and billing models. Together, pricing and billing determine what price you set for your solution and how you will charge your customers for their purchase. Although they are sometimes be used interchangeably, it’s important to note that pricing and billing are two different functions within your organization – pricing is a pre-sales activity while billing is a post-sales function.

Apart from when they occur in the sales cycle, another key difference is who in your business is responsible for these processes. We previously noted that pricing is predominantly a Marketing function, but it does involve input from a company’s Finance or Accounting team. Where do they come in during the pricing process? An essential part of pricing is financial numbers – you want to ensure you are setting a price for your solution that is high enough to not only cover your costs but generate revenue consistent with your overall strategic objectives. Your cost of goods sold is one of these need-to-know numbers that your Finance or Accounting team can help you with.

Along with your budget and operating expenses, your cost of goods sold is a key number that factors into your price. Knowing your COGS will help you set a price for your solution consistent with your pricing strategy. If you take a price skimming approach, setting a higher price following the launch of your product or service and lowering the price as competitor solutions appear on the market, you will initially have a larger margin between your COGS and your price point. This margin will shrink over time as you lower the price and, depending on your sales volume and market share, it may impact your revenue. Alternatively, if you take a penetration pricing approach, designed to capture a large market share by offering competitive pricing, the margin on your COGS will be relatively small to keep the price of your solution down.

Not knowing your cost of goods sold is like playing darts blindfolded. An effective pricing strategy is difficult even in situations where you can see your surroundings because there will always be unforeseen market dynamics at play. Even though there’s no magic formula that will guarantee a bullseye every time, knowing your COGS at least provides you with the knowledge necessary to hit the board and maintain a degree of control over how close you get to the bullseye.

Calculating Your COGS

1. Choose a period of time for your calculation.
2. Record your expenses over this period. Remember, your COGS should only include direct costs attributed to the production of your solution, such as:
   1. Raw materials
   2. Labour to produce the product or service
   3. Materials to deliver your product or service
   4. Production facilities
   5. Other direct costs
   6. General overhead (if applicable)
3. Add these costs. This is your total COGS over the timeframe specified above.
4. Determine how many products you sold or services you delivered in the timeframe specified above.
5. Divide your total COGS by the number of units sold/delivered in step 4. This is your COGS per unit.

Tip: Ensure you speak with your Finance or Accounting team when calculating your COGS to ensure you are using the right numbers and you have not overlooked anything necessary for an accurate COGS. Your team may also already have a method for calculating the cost to produce your solution in which case you could schedule a meeting to review the criteria and ensure it accurately reflects your production and delivery processes.

If you don’t have a formula for calculating your COGS, download our free COGS Calculator below to determine your costs. Simply input your expenses for each line to calculate the cost to produce your product or service as well as your COGS per unit. Or, if you prefer, you can download a PDF version here.

Source: https://blog.printfleet.com/blog/how-to-calculate-your-cost-of-goods-sold