What is the cost of goods sold (COGS)?

Cost of goods sold (or COGS) are the costs that are directly attributable to the goods your company sells. This includes the materials or parts that go into your product, as well as the direct labor costs associated with creating that product. Direct labor costs are the labor that is part of the production process and is involved in actually creating finished products.

COGS is similar to variable costs. If you are a retail business and purchase finished goods inventory from your suppliers, then your entire COGS may be the wholesale purchase price from your suppliers. If there are steps you need to take to make a finished product, those costs may also be a part of your COGS.

The formula to calculate COGS is:

For Trading Company

COGS = Beginning Inventory + Purchases During a Given Period – Ending Inventory

For Manufacturing Company

Components of COGS can include direct costs such as:

·        Cost of raw materials

·        Cost of shipping charges or duty fees

·        Direct labor costs for products

·        Overhead that can be directly attributed to production

Why is COGS important?

COGS is a very important part of the gross profit equation: Gross Profit = Revenue – COGS 

Reducing COGS is easier said than done: Reducing COGS sounds great in theory, but is actually quite difficult. As a business owner, you have probably already put a great deal of effort, whether conscious or unconscious, into making sure your business is profitable. One of the most important mechanisms is monitoring the price of your inputs.

TOP 15 strategies for reducing the cost of goods sold for your small business:

1. Negotiate with suppliers and vendors

Strong relationships with your suppliers are key to the success of your business, but that doesn’t mean you can’t try to get the best deal. In order to reduce your COGS, develop a systematic approach for negotiating with suppliers, whether new or existing. You want your suppliers to be profitable just like you are, but you want to avoid leaving too much money on the table.

Negotiable items with suppliers and vendors can include: asking for bulk discounts; asking for a discount in exchange for paying invoices more quickly; joining formal or informal buying cooperatives, where multiple retailers can join forces to negotiate for better prices; and periodically sending projects or orders out for a competitive bid.

Be mindful of the possible negative externalities of all of these strategies. For example, if you get a discount in exchange for bulk order, you will need to store that as inventory, which will create storage and handling costs. Inventory may also become obsolete and have to be written down. Make sure you come to all negotiations armed with data about how a supplier’s products are performing on the shelf or holding up in your products, how that supplier is performing as a partner, and what kind of a deal you need to make this supplier relationship viable.

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