What is COGS & How can it be Calculated?

A common mistake food business owners make is determining the cost price haphazardly. The first step you should take when starting a business is to accurately set the Cost of Goods Sold (COGS).

Why is this important? So that the products you sell aren’t too expensive or too cheap in the market. Moreover, you can determine the amount of profit you want to achieve since the profit can be reinvested into other business needs. Besides pricing, don’t forget to continually improve your products to stay competitive, which will also incur additional costs.

To help you calculate COGS accurately, let’s first learn the components and formulas involved below.

What is COGS?

COGS, or Cost of Goods Sold, refers to the total cost of goods sold by a company or business. This includes all production costs, both direct and indirect. The main goal of calculating COGS is to ensure optimal profit. Additionally, COGS needs to be set at a price that matches the purchasing power of your target market, ensuring the product is well-received.

COGS calculation is also crucial for determining gross profit and gross margin. The higher the COGS, the lower the gross profit you will earn. Costs included in COGS cover raw materials, labor wages, production costs, overheads, and other variable expenses. In short, COGS includes all costs from the beginning to the end of the production process, including non-operational expenses.

Read also: Want Your Business to Grow? Learn About Profit and Loss First!

COGS vs. Operational Costs

Source: Freepik.com

COGS and operational costs are different. COGS includes direct costs incurred to sell a product or service to customers, such as purchasing raw materials and paying direct labor. 

On the other hand, operational costs are related to the day-to-day running of the business but aren’t directly tied to generating revenue. For a cost to be considered operational, it must be a regular expense necessary for running the business. Examples include insurance or the cost of renting a service or space.

COGS Formula and Calculation Example

Source: Freepik.com

When calculating COGS, several related components come into play:

COGS = Net Purchases + Beginning Inventory – Ending Inventory

Here’s a step-by-step guide with an example:

1. Calculate Net Sales

First, calculate net sales using this formula:

Net Sales = Total Sales – (Returns + Sales Discounts)

For example, Angger’s fried chicken restaurant has total sales of IDR 10 million in a month. There are returns of IDR 3 million and a discount of IDR 1.5 million, leaving Angger with net sales of IDR 6.5 million.

2. Calculate Net Purchases

Next, calculate net purchases using the following formula:

Net Purchases = (Gross Purchases + Shipping Costs) – (Purchase Discounts + Returns)

Continuing with the previous example, Angger’s gross purchases amount to IDR 5 million with shipping costs of IDR 600,000. After returns of IDR 150,000 and discounts of IDR 300,000, Angger’s net purchases total IDR 5.15 million.

3. Inventory

To find the value of inventory, use this formula:

Inventory = Beginning Inventory + Net Purchases

For example, Angger’s fried chicken business starts with IDR 3 million in inventory, with IDR 1.5 million left at the end of the period, totaling IDR 4.5 million in inventory.

4. Calculate COGS

After determining net sales and net purchases, move on to the COGS calculation using one of these formulas:

COGS = Inventory – Ending Inventory

Using the example above, Angger’s total inventory for the month is IDR 3 million, with an ending inventory of IDR 1.5 million. Therefore, the COGS is IDR 1.5 million

Alternatively, you can calculate it using:  

COGS = (Beginning Inventory + Net Purchases) – Ending Inventory

And there you have it—an easy way to calculate COGS! Make sure your financial reports are always accurate so your COGS calculations are precise, helping you set the right cost for your products.

Additionally, you can adopt ERP software to assist with COGS calculations, like ESB Core, which provides integrated data management, inventory control, and cost efficiency improvements of up to 35%. With ESB Core, managing COGS becomes more effective and easier.