Business Math: How to Calculate the Cost of Goods Sold

Understanding the Cost of Goods Sold (COGS) is important for businesses to measure efficiency and profitability. In this article, we’ll explain what COGS is, how to calculate it, and why it matters for your business.

What is the cost of goods sold?

The cost of goods sold refers to direct expenses related to the purchase or production of goods or services. COGS includes the costs related to labor, raw materials, and overhead expenses directly associated with production. Overhead expenses such as rent should not be part of the COGS calculation.

Benefits of understanding COGS

Calculating COGS is important to understand how much it really costs to create or acquire a product. This insight informs decisions and ensures accuracy across many critical areas of the business:

• Profit Margins
• Pricing Strategies
• Efficiency Evaluations
• Tax Deductions
• Inventory Management
• Investor Confidence

How to Calculate COGS

With a few pieces of information and these simple steps, you can calculate the cost of goods sold for your business:

Step 1: Start with beginning inventory

First, identify the value of your beginning inventory–leftover inventory from the previous accounting period. This should include finished goods, raw materials, and items in progress.

Step 2: Add Purchases

Next, calculate the total cost of raw materials, inventory, or supplies that were manufactured or purchased in the current accounting period.