Cost of sales (calculated as Beginning Inventory + Purchases – Ending Inventory + Direct Expenses) is important for business profitability. It encompasses all costs directly tied to production and sales, impacting pricing, inventory, and financial reporting. Accurate calculation ensures optimal resource allocation and informed decision-making.
Cost of sales is a crucial indicator in running a business. This includes many costs (excluding sales expenses and certain others). This formula allows you to monitor production capacity and balance costs effectively.
Understanding business profitability is essential for business. You will gain insights into calculations, identify the areas that bring the most benefits, and pinpoint the aspects that need improvement.
In this blog, we provide a handbook for understanding and determining the cost of sales. Moreover, we also differentiate it from the cost of goods sold and net sales.
What is the cost of sales?
In simple terms, the cost of sales definition is an inventory accounting figure that tells you the actual cost to create and sell a product. Encompassing both the cost of goods sold and any other directly attributable expenses.
For businesses, this is a significant indicator. The typical components of cost of sales you should know:
- Cost of goods sold (COGS)
- Direct labour (if not already included in COGS)
- Direct materials (if not already included in COGS)
- Sales commissions
- Sales-related expenses
It is important to note that this term is not always used in every field. Businesses may use a different term to replace it, such as “cost of goods sold” or “cost of revenue.” Some companies may simultaneously use those accounting and finance terms in their financial reports.
Cost of sales explained: A vital metric for business success
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What is included in the cost of sales?
The cost of sales encompasses many components. What is included in the cost of sales? To analyze, we need to break down this cost to understand exactly what it includes.
Breakdown of costs included in sales:
- Direct labour: The direct costs your business pays to employees (those who directly contribute to the production process or service delivery). For example: wages, salaries, benefits, etc.
- Raw materials: The cost of basic materials and elements used to produce finished goods.
- Production costs: Costs related to production, including rent, depreciation, and more.
- Other expenses: Based on the type of your business. For example, sales commissions, packaging costs, delivery costs, credit card processing fees, etc.
Breaking down the components of cost of sales
Read more >>> How to Calculate Total Manufacturing Cost – Full Formula
Calculating the cost of sales
Cost of sales calculation is a common issue in financial analysis. So, how to calculate cost of sales for inventory? You’ll discover the method through a few simple formulas.
The basic cost of sales formula for getting the result:
Cost of Sales = Beginning inventory + Purchases – Ending inventory + Direct expenses
The meaning of each element in this formula:
- Beginning inventory: The initial inventory value at the commencement of your new accounting period. Includes products and raw materials carried over from the previous period.
- Purchases: Related to the costs incurred for acquiring new inventory throughout the period.
- Ending inventory: Inventory value after the period. Comprises unsold goods and leftover raw materials.
- Direct expenses: Includes sales commissions, delivery costs, and more.
To visualize, consider an example:
You own a clothing store. At the start of the month, you have 100 shirts for preparation. During the month, you purchase an additional 200 shirts. After a period of sales, the remaining inventory is 50 products.
Your additional expenses, like employee wages and transportation, total 1,000 USD. The price per product is 50 USD.
The result: Cost of sales = (100 x 50) + (200 x 50) – (50 x 50) + 1000 = 13500 USD
Calculate your cost of sales with this simple formula
The way to find and calculate the cost of sales
When conducting financial analysis, “How to calculate the cost of sales” is frequently asked. Keep reading the next section.
Although the formula above is an example, in practice, the cost of sales can appear in different forms. Some adjustments are needed to get accurate results. Check out practical examples for different industries:
For manufacturers: Refer to the following formula:
Cost of sales (for manufacturers) = Beginning finished goods inventory + Cost of goods manufactured (COGM) – Ending finished goods inventory.
For retailers: Using the formula below will usually help you easily account for inventory. Shipping and transaction fees may be included for eCommerce companies.
Cost of sales (for retailers) = Beginning inventory + Purchases – Ending inventory.
For service businesses: The total input costs, including facilities and service staff, are often calculated. Note that office staff are excluded. In the case of remote work (or working from home), these costs will not include travel expenses and equipment. An illustration of the calculation formula for service businesses:
Cost of sales (for service businesses) = Sales commission + Service delivery employees + Service delivery workspace + Travel + Equipment use.
Calculate your cost of sales: Industry-specific examples
Read more >>> What Is Profit Margin? How Does It Impact Your Business?
Cost of sales vs. Cost of goods sold (COGS)
Many people may confuse two concepts. The cost of sales and COGS aren’t the same as many think.
Some highlights to distinguish the cost of sales vs COGS:
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Feature
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Cost of sales
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Cost of goods sold
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Focus
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All direct expenses related to generating revenue.
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The direct expenses involved in manufacturing goods.
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Scope
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Broader, encompassing COGS and other direct expenses.
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Narrower, limited to manufacturing expenses
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Components
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Includes COGS, sales commissions, delivery costs, and other direct selling expenses
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Includes direct materials, direct labour, and manufacturing overhead.
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Relationship
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COGS is a component of the cost of sales.
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In many cases, these two definitions can also be used interchangeably.
- Service businesses: The cost of sales and COGS are similar. Using COGS interchangeably. The reason is that this formula involves certain expenses, such as commissions and shipping fees.
- Manufacturing businesses: Often use the COGS formula.
Cost of sales vs. COGS: Understanding the key differences
Net sales vs. Cost of goods sold
Net sales vs cost of goods sold exhibit distinct differences in their concepts. Through the following information, you will understand how they differ.
Net sales represent the total of a company’s gross sales (after subtracting returns, allowances, and discounts). Calculated this metric is not always clear to external parties. They are often included in the top-line revenue figures reported on the income statement.
Net sales are related to both COGS and cost of sales. Based on COGS and Net sales, Gross Profit can be calculated. With some expenses like revenue, cost of sales, operating expenses, and taxes, net income can be easily calculated.
To visualize, you can look at the two formulas:
Gross profit = Net sales – COGS
Net income = Revenue – Cost of sales – Operating expenses – Taxes
Net sales, COGS, and profitability: Understanding the connection
Cost of sales percentage
By dividing the total cost of goods sold by the total sales, the cost of sales percentage is derived. Then, multiply the resulting value by 100 to express it as a percentage.
How to find cost of sales percentage? Here is the formula:
Cost of sales percentage = (Cost of sales / Revenue) x 100
After the calculation, the revenue manager will have a percentage figure. This percentage will vary across industries. For example, in the F&B industry, this percentage should typically be around 25-35%. The accuracy of this percentage will hinge on how correct your data is. Therefore, make sure to gather precise information.
Calculate your cost of sales percentage for better financial insights
Importance of cost of sales in financial analysis
Cost of sales is a key indicator in financial statement analysis. Understanding it helps you improve the current company’s financial health.
Typically, the cost of sales position is near the top of the income statement. Some other values may appear in different sections of the balance sheet. This figure is closely related to other numbers, such as revenue, gross profit, operating expenses, and net income.
The cost of sales is used to analyze profitability and assess business performance. Through that, you will know which areas you should improve to achieve better profits.
Monitoring the cost of goods sold will help you assess the company’s situation. It will show whether things are running well or which areas need improvement. The cost of sales will measure the costs of materials and other expenses.
However, if this figure doesn’t align with revenue, it’s necessary to reassess cost management and find ways to maximize profits.
Cost of sales and your bottom line: Analyzing profitability
Conclusion
To sum it up, the article was all about the cost of sales. Emerged with a comprehensive grasp of its definition, calculation, and why it’s such a big deal. Distinguish between the cost of sales and the cost of goods sold.
These concepts can be interchangeable, but they are fundamentally different. You should leverage the cost of sales analysis. This will help you optimize profits and manage your business finances more effectively.
Manage and operate your business effectively by gaining new knowledge. Explore more financial analysis concepts at SourceVietnam.com.
FAQs about Cost of sales
What is included in the cost of sales?
There are many factors in this indicator, but basically, the cost of sales is included:
- Direct labour (wages, salaries, benefits).
- Raw materials.
- Production costs (rent, utilities, depreciation).
- Other Expenses (sales commissions, packaging costs, and more).
How to find the cost of sales percentage?
Use the formula below to determine the percentage:
Cost of sales percentage = (Cost of sales / Revenue) x 100
Cost of sales formula for small businesses?
Usually, the formula for each industry will differ slightly. Applying the following formula to calculate the cost of sales for small businesses:
Cost of Sales = Beginning inventory + Purchases – Ending inventory
Difference between net sales and cost of goods sold?
Net sales vs the cost of goods sold are two distinct metrics. Each carries its significance. Specifically:
- Net sales: Total revenue a company earns from selling. Subtracting any reductions like returns, allowances, etc. Functions as the initial figure presented on a company’s income statement.
- Cost of Goods Sold (COGS): Expenses directly linked to the creation of the goods sold. Includes the expenses for materials involved in crafting the product. Combined with the direct labour costs required.
Difference between the cost of sales and COGS?
The cost of sales vs Cost of Goods Sold (COGS) is different. Here’s how they differ:
- Cost of sales: Extends beyond the immediate expenses of production, including expenses like direct labour and overhead tied to revenue generation.
- COGS: Covers the direct costs involved in producing for sale. It counts material costs for production and direct labour expenses involved in creating the goods.
How to calculate the cost of sales for inventory?
The formula, despite its appearance, is straightforward. Simply apply the following method:
Cost of Sales = Beginning inventory + Purchases – Ending inventory
How do you calculate the cost of sales for a retail business?
To determine the cost of sales in a retail business, use the following formula:
Cost of Sales = Beginning inventory + Purchases – Ending inventory
What makes accurately calculating the cost of sales crucial?
Accurately calculating the cost of sales will bring many benefits. But clearly, you can see that this will provide you with:
- Better pricing strategies.
- More efficient inventory management.
- More accurate sales reporting and financial statements.
- Improved business performance and more.
