The cost of sales, also known as cost of goods sold (COGS), is the total expense a business spends to produce or purchase the products it sells. Calculating this figure is important for determining profit and understanding how efficiently a business is running. It helps in setting prices, managing expenses, and evaluating financial performance. Here is how to work out cost of sales.
- Understand What Cost of Sales Includes
The cost of sales covers all direct costs related to producing or buying goods for sale. This includes raw materials, labor, and manufacturing expenses for producers, or purchase costs for retailers. It does not include indirect costs like marketing, rent, or administration.
- Use the Basic Formula
The standard formula for cost of sales is:
Opening Stock + Purchases – Closing Stock = Cost of Sales
Opening stock is the value of goods you already have at the beginning of the period. Purchases refer to new stock bought or produced. Closing stock is the value of unsold goods at the end of the period.
- Apply the Formula with an Example
For example, if a business starts the year with stock worth $5,000, buys additional goods worth $10,000, and ends with stock worth $3,000, the cost of sales would be:
5,000 + 10,000 – 3,000 = $12,000
This means the business spent $12,000 on goods sold during the period.
- Consider Direct Costs in Manufacturing
If you run a manufacturing business, include costs such as raw materials, direct labor, and factory expenses. These must be added to purchases before subtracting closing stock to reflect the true cost of making the products.
- Use Accurate Stock Valuation
The accuracy of your cost of sales depends on how you value your opening and closing stock. Methods such as FIFO (first-in, first-out) or LIFO (last-in, first-out) can affect results, so be consistent with your chosen method for proper financial reporting.
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