Understanding Cost of Goods Sold and How to Calculate It

When running a business, it is certainly essential to determine the Cost of Goods Sold (COGS). This is a crucial component that must be included in the financial statements to assess whether a business is making a profit or incurring a loss in its sales. Therefore, it is essential to first understand the definition of cost of goods sold and how to calculate it.

Understanding the Cost of Goods Sold

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Cost of Goods Sold, commonly referred to as COGS, is the total expenditure and expenses incurred directly or indirectly to produce a product or service. This includes costs such as labor, materials, and overhead. You need to determine the COGS for each item sold to calculate the profit. This COGS should be set to align with the target market and be acceptable to the public.

Although it seems straightforward, if the pricing is incorrect, the company could suffer losses. Therefore, it's important to understand that each cost in COGS is directly related to a specific product sold by the company. Thus, COGS needs to be established so the company can know the detailed costs of that product.

Importance of Calculating Cost of Goods Sold (COGS)

In addition to determining the selling price of the products or services offered, COGS is also used as a benchmark to assess the desired profit or earnings of the company.

The company will also need funds to pay employees who handle the processes and for various other operational activities. This is another reason why calculating COGS is very important. COGS can inform the company how much profit can be made, which can then be used for operational costs.

Components of COGS

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There are several important components in COGS, and here are the explanations for each:

1. Beginning Inventory of Merchandise

This refers to the inventory at the beginning of the company's accounting period. The balance of this beginning merchandise inventory can be checked through the trial balance of the current period or the balance at the start of the previous year.

2. Ending Inventory of Merchandise

Next is the ending inventory of merchandise available at the end of the company's accounting period or the end of the current fiscal year. The value of the balance for this component can be found in the company’s adjustment data at the end of the accounting period.

3. Net Purchases

Finally, net purchases in COGS include all merchandise purchases made by the company, whether in cash or on credit. Additionally, this includes freight-in costs and is reduced by purchase discounts and returns that are currently happening. In simple terms, COGS has a formula to calculate its value: Net Purchases + Beginning Inventory – Ending Inventory.

That’s the definition of Cost of Goods Sold (COGS), which is a crucial factor for a business or company to determine the selling price so you can calculate the profit or earnings obtained. In business management, you can also use the Youtap POS application, which makes all operational activities easier by assisting in the creation of sales reports, online payments, and more. 

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