Are you measuring the cost of goods sold correctly? Below is everything you have to understand about COGS.
Although an e-commerce company is complex, it is important to get the financials in order to get the cost of products under control. Precise inventory control is arguably the most critical aspect of any efficient eCommerce platform since it will pressure cash flow to hold so many of the inventory resources or target low-margin items.
The cost of goods sold is therefore the biggest cost of any organization dependent on inventory and should be taken very seriously. Here’s what you need to know about the management of COGS for your e-commerce business.
The Significance of COGS
If your company sells goods, it is very likely the inventory is handled by your company. If this describes your business, then it’s crucial that you know how to measure the cost of products sold and how your bottom line is impacted.
Any cost related to selling the goods involves weighing COGS. Depending on how many products you deliver and the size of the supply chain needed to produce them, the process of measuring the cost of goods sold for the products you distribute, manufacture or offer can be a complicated task.
The Balance Between COGS and Inventory
COGS calculation depends on the total amount of inventory that the organization maintains. If a tangible commodity is marketed by your company, inventory is classified as the products that you sell. In certain situations, inventory may be goods bought from a wholesaler. In other instances, the stock may be items that the company has made.
Other companies may keep an inventory of components or materials that are used to produce the products they sell. It is a critical business commodity, no matter what the inventory comprises, with a quantifiable valuation.
Calculating the expense of the products sold starts at the beginning of the financial year with inventory and finishes at the end of the financial year with inventory. In order to measure the worth of their products, most inventory-based firms take inventory at these junctions.
In most instances, it will be put in a storage center, or with a third-party distribution company, by a corporation that starts and purchases inventory. This reflects a considerable initial expenditure which for some time does not translate into revenue.
It is a typical error made by inventory-based companies to report inventory costs at the time of purchase, rather than waiting for inventory to be sold. In this way, taking inventory will trigger income statement anomalies and show a company as a less secure investment.
What do you need to know about the cost of merchandise sold?
There are a variety of important statistics that firms focused on e-commerce or inventory need to realize regarding the cost of products sold:
The cost of goods sold is the primary cost of an inventory organization
When estimating taxable income, wrongly measured COGS will result in errors.
Incorrectly measured COGS would reveal incorrect figures of profit margins
Inaccurate gross margin figures can create tension in the organization and make it impossible to handle inventory.
COGS and profit margins specifically influence cost, marketing budget, and order quantity decision-making.
COGS Examples
This is an example of how tracking the incorrect cost of the products sold will have a direct effect on the main statistics impacting your company’s operation.
Incorrect COGS Attribution
COMPANY A
Jun
Jul
Aug
Product Sales
1500
1500
1500
COGS
-3000
0
0
Gross Profit
-1500
1500
1500
Marketing
-100
-100
-100
Website
-50
-50
-50
Staff
-500
-500
-500
Software
-50
-50
-50
Utilities
-50
-50
-50
Insurance
-50
-50
-50
Net Income
-2300
700
700
In the above case, during the same month, the product was bought, the company reported inventory costs rather than waiting until the inventory was sold. This pattern resulted in a loss of -$2,300 in the first month reported.
The firm sold inventory over the next two months, however, but did not report any purchases, which makes revenue look higher than it really is. In addition, decision-making is affected by this activity. The obfuscated sales equation makes benefit estimation virtually impossible as the corporation wants to decide if it has the money to recruit fresh hires or raise marketing spend in this case.
Correct COGS Attribution
COMPANY B
Jun
Jul
Aug
Product Sales
1500
1500
1500
COGS
-1000
-1000
-1000
Gross Profit
500
500
500
Marketing
-100
-100
-100
Website
-50
-50
-50
Staff
-500
-500
-500
Software
-50
-50
-50
Utilities
-50
-50
-50
Insurance
-50
-50
-50
Operating Income
-300
-300
-300
The company has correctly reported COGS in this case. As the financial statement is far more predictable, a prospective corporation considering this enterprise as a future investment opportunity would find this scenario much less appealing.
In example 2, in an incremental fashion, the cost of products sold is expensed over time. This means that the measurement of COGS is in line with the number of goods sold.
Conclusion
It is necessary to remember the time frame in which you include the cost of products sold when measuring COGS in conjunction with inventory sales and income statements. When accounting for inventory purchases, it’s important to only include the expense on your business income statement as the product the expense relates to is sold.
Incorrectly tracking your inventory costs not only keeps prospective buyers from capturing a reliable measure of your company’s worth, but also makes it more difficult to make rational investment decisions.
Inventory management and accounting can be complicated—small accounting mistakes can have a huge effect on the health of the company. If you need feedback or advice on inventory accounting, please reach out to fortis today.
