Along with start-up expenses, one type of expense you’ll need to figure out when starting your small business is called cost of goods sold, or COGS.
What is cost of goods sold?
For retail or wholesale businesses, your cost of goods sold is the price you paid to acquire the products that you’ll sell to your customers – in other words, the direct costs of what you sell.
For a manufacturing business, your COGS includes the cost of the raw materials, labour and supplies used in the manufacturing process. Your labour costs include the process of fabricating the raw material into a finished product ready for sale. So, for example, the cost of turning pieces of leather into functioning handbags.
For a pure service company, there usually isn’t any COGS. You’ll make your income from service fees instead of the sale of products — you sell the intangible. However, most businesses sell both products and services. For example, a hairstyling business sells both services (haircuts, colouring) and products (shampoos, conditioners, brushes, styling products).
Knowing your cost of goods sold can help you understand your profit, as well as the efficiencies – or maybe lack thereof – in your business model.
How to calculate cost of goods sold
The cost of goods sold estimate includes raw materials, labour used in production processes, supplies, and products purchased for resale. Most small businesses use the following formula to calculate their COGS expense:
Value of goods inventory at the beginning of the period
Value of any goods purchased for resale during the period
Value of goods inventory at the end of the period
The cost of goods sold during the period