In terms of services, product cost is the cost incurred on the labour required to deliver the services to customers. These costs include the costs of direct labour, direct materials, and manufacturing overhead costs. Product Cost refers to the costs incurred in manufacturing a product intended to be sold to customers. The cost of goods sold also referred to as Cost of Sales is an important item on the income statement of your company as it helps in determining Gross Profit, a profitability measure that demonstrates the efficiency of your business in managing raw material and labour. Whereas, the closing inventory is the unsold inventory at the end of the current financial year. Therefore, COGS is calculated by adding the beginning inventory and any further purchases made during the year and then subtracting closing inventory from the sum of opening inventory and additional purchases.īeginning inventory is nothing but the unsold inventory at the end of the previous financial year. The indirect costs such as sales and marketing expenses, shipping, legal costs, utilities, insurance, etc. It includes only those costs that are directly incurred in order to manufacture the goods including the cost of labour, raw material, and overhead expenditure related to the manufacturing of goods to be sold. So in this article, let us try to understand what is the Cost of Goods Sold, COGS Formula, and different Inventory Valuation Methods.Ĭost of Goods Sold (COGS) refers to the costs associated with acquiring or manufacturing goods to be sold by a company during a specific period of time. Thus, the type of method used by a company to value its inventory has an impact on its ending inventory and cost of sales. These include Specific Identification, First-In-First-Out (FIFO), and Weighted Average Cost Methods. International Financial Reporting Standards (IFRS) has stipulated three cost formulas to allow for inter-company comparisons. Therefore, we can say that inventories and cost of goods sold form an important part of the basic financial statements of many companies. Now, in order to record the cost of inventories in the books of accounts, manufacturers can either record the amounts of raw materials, work-in-progress and finished goods separately on the balance sheet or simply showcase the total inventory amount. Therefore, manufacturers classify inventory into three categories: raw materials, work-in-progress, and finished goods Work-in-progress inventory is nothing but the inventory that is still under process and is not yet converted into finished goods to be sold to customers. On the other hand, manufacturers first purchase raw materials from suppliers and then transform these raw materials into finished goods. Merchandisers, including wholesalers and retailers, account for only one type of inventory, that is, finished goods as they purchase the ready for sale inventory from manufacturers. For such companies, inventory forms an important asset on their company balance sheet. To learn how to calculate COGS, you’ll need to know your way around the cost of goods sold equation.Merchandising and manufacturing companies generate revenue and earn profits by selling inventory. Understanding the cost of goods sold equation Third-party software used for in-house applicationsĬustomer success costs related to up-selling/cross-selling If the answer is yes, then the cost probably isn’t directly related to production/delivery and it would be better to leave it out of your cost of goods sold equation entirely.įor the avoidance of doubt, here are some of those costs that probably aren’t relevant for SaaS COGS: If you’re unsure what to include in your SaaS COGS equation, just ask yourself one basic question: could I still deliver this service if I don’t pay for this expense? If the answer is no, then it needs to be included. Here are some of the key costs you need to include in your cost of goods sold equation:Įmployee costs (for employees directly involved in production and delivery)Ĭustomer support and account management costs But which of your expenses should be counted as part of COGS for SaaS? Working this out may be trickier than you’d imagine, as COGS excludes indirect expenses such as certain overheads that don’t contribute to the production/delivery of your products. The cost of goods sold are the direct costs associated with the production and delivery of goods sold by your company. Explore the importance of cost of goods sold for SaaS businesses with our simple, comprehensive guide. Although in many ways, cost of goods sold (COGS) is just a simple accounting principle that measures the costs your business incurs when producing and delivering products and services, it holds a special level of importance for businesses in the SaaS space.
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