What COGS is and how to calculate it for your eCommerce?

Learn how to calculate the COGS (cost of goods sold) in your eCommerce and improve the profitability of your business.

What the COGS is

COGS is the acronym for "Cost of Goods Sold", which in English means "cost of goods sold". It is an accounting term used to calculate the total cost of goods or products sold by a company during a given period, usually a year, although it can be a shorter period.

It includes all direct costs associated with the production and sale of a product, such as the cost of materials, direct labor and all indirect costs associated with production, such as factory rent.

COGS is important to the company's accounting and management because it is used to calculate its gross margin, which is calculated as the difference between total revenue minus cost of goods sold (COGS). By knowing COGS, the company can determine how much gross margin it is making on each sale and, therefore, can make informed decisions about pricing, cost management and production planning.

What is included in COGS ?

As mentioned above, COGS (cost of goods sold) includes all direct costs associated with the production and sale of a product. These costs may vary depending on the type of business, but generally include:

Cost of materials: as the costs of materials directly used in the production of the product, such as raw materials, components and supplies.
Direct labor: the costs of direct labor used in the production of the product, such as wages and benefits of workers involved in production.
Manufacturing overhead: the indirect costs associated with production, such as factory rent, utilities, machinery depreciation, insurance and other related expenses.
Shipping and warehousing costs: those costs associated with the storage and shipment of finished product, including packaging, transportation and storage charges.

Best practices for inventory management

Proper inventory management is one of the practices that can contribute most to improving COGS. After all, inventory management seeks to optimize a company's stock as much as possible in line with demand so that, on the one hand, there are no stock-outs and, on the other hand, unnecessary stock is not stored in the company's warehouses.

In this regard, it is important to plan the objective demand with adequate precision in order to ensure that adequate stock is available at all times (plus the obvious safety stock necessary to avoid possible problems due to loss or breakage of goods).

If more inventory is stored than the company needs, the COGS increases and, consequently, the company's profitability is reduced. But, on the other hand, it is not advisable to have just the right amount of stock, since any eventuality can put the goods at risk of non-delivery, leading to dissatisfaction on the part of the customers.

Monitoring and analysis

COGS tracking and analysis is essential to understanding a company's production costs and determining whether effective efforts are being made to reduce them. Below are some of the ways companies can track and analyze COGS:

Keep accurate records: Keeping accurate records of production costs is essential for COGS analysis. This includes records of materials used, labor costs and overhead.
Use analysis tools: Using analysis tools such as graphs and charts can help identify trends and patterns in production costs. This can help identify problem areas and opportunities to reduce costs.
Analyze profit margins: Analyzing profit margins by product or service can help determine which products are most profitable and what adjustments can be made to improve profit margin.
Make comparisons: Comparing the company's production costs to those of the industry or competitors can help determine whether the company is being cost competitive.
Identify areas of opportunity: Identifying areas of opportunity to reduce COGS is essential in order to implement effective strategies. This may include identifying inefficient processes, improving inventory management or seeking more cost-effective suppliers.
Establish goals and metrics, so that COGS can be used to help the company measure its progress in reducing production costs. This may include cost reduction targets and metrics to measure production efficiency.

Strategies to reduce COGS

Below are some strategies that can help reduce a company's COGS:

Negotiate with suppliers to obtain lower prices on materials and services needed to produce your company's products or services. It is possible to obtain volume discounts or exclusive supply agreements.
Optimize the production process, identifying production processes that are inefficient and increase costs. In this sense, it is important to look for ways to optimize them, either through automation, reorganization or simplification of processes.
Control of labor costs, which can end up being a large component of COGS. To this end, ways can be found to optimize scheduling and labor time, reduce absenteeism and turnover, and increase workplace efficiency.
Improve inventory management: Proper inventory management can reduce warehousing costs and minimize the loss of unsold products. To do this, it is important to use inventory analysis techniques to identify areas of opportunity and ensure that only the products that are needed are produced or purchased.
Use advanced technology and systems: Advanced inventory and production management systems, as well as automation technology, can help reduce process costs and increase efficiency.
Review product design: Reviewing product design to find ways to reduce material cost and production complexity can also be an effective way to reduce COGS.

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