What Are Cost of Goods Sold?



Cost of goods sold (COGS) are the costs of producing the products that a company sells
The costs included in the COGS calculation are those which directly relate to the procurement or production of the goods the company sells. For a retailer these are the items purchased for resale, but for a manufacturer or hospitality business they would include the materials, manufacturing labour, and ingredients directly attributable to production.

Indirect expenses such as distribution costs and sales costs (such as sales assistant wages) are not classified as a cost of goods sold.

Cost of goods sold shows in the company's Profit & Loss Statement (P&L Statement).

The P&L Statement offers business's important information regarding the progress of the company and is an invaluable report that helps owners manage their businesses.

Costs of goods sold show the P&L statement as direct costs of producing the company's goods and services.

Sales – COGS = Gross Profit

Gross profit is the indicator of a business’s performance after deducting COGS. Over time analysis of Gross Profit margins reveals whether a business is performing better or worse.

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Cost of Goods Sold versus Fixed Costs?

A cost that does not change with an increase or decrease in the number of goods or services produced is known as a fixed cost. A fixed cost is an expense are incurred regularly and do not vary based on sales performance.

Fixed costs include expenses such as rent, interest expenses, insurance, property taxes, utility expenses, and fixed annual salaries of its employees.

What about Variable Costs?

Variable costs are expenses that proportionately change when the volume of goods and services sold or produced are increased.

COGS are variable costs but so are sales commission, outwards freight costs, and other expenses that vary based on sales volumes but not are not a direct cost of production.

An example of this would be sales commissions on every product sold. If no items are sold, the sales commission will be $0. However, as the number of products sold increases, the variable cost will increase depending on the percentage of commission on each sale.

Variable Costs or Mixed Costs?

A mixed cost consists of two components; fixed and variable. For example, the annual expenses of operating a vehicle for distributing stock is likely to be a mixed cost.

Some expenses are fixed as they do not change, regardless of how often the car is used (such as insurance, licensing and depreciation).

However, other expenses are variable because they will increase or decrease depending on the amount the vehicle is used (such as fuel costs and maintenance).

Understanding various operating costs and how they change based on company performance is key to leveraging business performance to improve Net Profit and Cash Flow.

Looking for a Chartered Accountant in Auckland or Tauranga?

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Contact the team at Engine Room Chartered Accountants in Pukekohe on 09 238 5939 or the Tauranga team on 07 579 5011.