The term cost of goods sold is one of the terms used extensively in accounting operations and trade, and it represents a part of the income statement, and naturally the costs are related to the product or goods sold by the company, in the event that the cost of goods sold exceeds the revenues that the company has achieved during the reporting period , This means that there was no profit, and the calculation of the cost of goods sold is important to the management, because it helps in analyzing the extent of control over the purchase costs and salaries, and in this article we will show you everything you want to know about the cost of goods sold with examples
Meaning of cost of goods sold
In the beginning, the cost of goods sold is a cost that is the direct costs that lead to the production of the goods sold in the company, which includes the cost of the materials used to create that good together with the direct labor costs used to produce the good.
However, indirect expenses, such as distribution costs and sales costs, are excluded. Sometimes the cost of goods sold is referred to as “cost of sales”.
An example of the cost of goods sold
In order for the picture to be more clear, and to be able to understand what is meant by the cost of the available goods, we will show you an example explaining what is meant by that term, where, for example:
The cost of goods to a specific car manufacturer will include the material costs of the parts that go into the configuration of the car in addition to the labor costs used to assemble and test the car, and we note that the cost of sending cars to dealerships will be excluded.
Besides excluding the cost of labor used to sell the car, as well as the costs incurred on cars that were not sold during the year, so we can say that the cost of goods includes all direct costs in producing the good or service that was sold to customers during the year.
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Cost of Goods Sold Formula
After we know what is meant by the cost of goods sold, we will now need to know the formula for it, and we note that the inventory that is sold appears in the income statement under the calculation of the cost of goods sold for the goods sold during the year by using this formula:
Cost of Goods Sold = Balance of inventory beginning of the period + Purchases from inventory during the period – Closing balance of inventory.
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How to calculate the cost of goods sold
After identifying the formula used to calculate the cost of goods sold, we will need to know how we use it specifically, so we find that the stock at the beginning of the period is the inventory remaining from the previous year, i.e. the goods that were not sold in the previous year, so any additional productions or purchases made by a manufacturing company are added. Or a retail company to stock in the beginning.
As for the end of the year, the products that have not been sold are subtracted from the sum of the initial inventory and additional purchases, and the final number extracted from the calculation is the cost of goods sold for this year, and here is a numerical example of the cost of goods sold until the picture becomes clear:
If we have a car company, and the balance of the closing stock for the year 2017 is $2,500,000, and the balance of the closing stock for the year 2018 is $2,670,000, and as for the purchases from the stock during the year 2018, it is $740,000, then:
If the cost of goods sold = 2,500,000 + 740,000 – 2,670,000 = 570,000 dollars
Cost of goods sold and associated financial ratios
The cost of goods sold is used by investors and analysts in many financial ratios, the most important of which are:
- Inventory Turnover = Cost of Sales ÷ Average Inventory
- Average Storage Period = Average Inventory ÷ Cost of Sales
- Gross Profit Margin = (Net Sales – Cost of Goods Sold) / Net Sales
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Cost of goods sold and inventory
You may be wondering about the relationship between the cost of goods sold and inventory, and in fact there is a close relationship between them, as companies that participates in the process of making and selling physical goods must record their goods as assets in their books and expenses at the time of their sale.
Usually, most manufacturing companies deal with 3 types of inventories, which are materials, work and final goods, while retailers deal with only one stock, which is goods, but in all cases, any company or trader will need to sell the stock in order to make profits, but before selling it. It acts as the asset of the company.
After the sale of that inventory, it is recorded in what is called the cost of goods sold (COGS), and then the process of transferring costs from the balance sheet item to the income statement item, and in general, most companies maintain a large amount of inventory to manage their daily operations.
Therefore, it is an important asset that must be monitored well, especially since large inventory may cause problems related to low cash flows, storage costs, and losses resulting from the possibility of deteriorating inventory, and too little inventory can lead to loss of sales and customers.