What Is the Cost of Sales?
Cash flow is vital for all small businesses, but if you dont understand the internal movement of your companys capital, cash flow becomes extremely difficult to manage. Thats why understanding how to calculate the cost of sales is so important, giving you the information you need to stay on top of your businesss financial health. Learn a little more about the meaning of the cost of sales with our comprehensive article. Cost of sales, also referred to as the cost of goods sold (COGS), represents the direct costs related to the manufacturing of goods/services that are sold to your customers. Cost of sales doesnt include selling, general, and administrative (SG&A) expenses, while it also leaves interest expenses out of the equation. In short, cost of sales is a very important financial performance metric, as it tracks your ability to manufacture/deliver goods and services at a reasonable cost. One of the main points about the cost of sales calculation that people get stuck on is which expenses need to be included, and which dont. If you stopped paying for a certain expense and could still manufacture the goods or deliver the service, then that expense should not be included in your cost of sales formula. However, if failing to pay for a specific expense would cause production to grind to a halt, it should be included in your calculation. While this depends entirely on your business, as well as the sort of products that youre manufacturing, the following items arent directly or indirectly involved in production, and therefore shouldnt be included:  Customer success costs, particularly those related to up-selling  Commissions for your salespeople  Cost of specific overheads  Cost of product development  How to calculate cost of sales  Theres a simple cost of sales formula that you can use to calculate your companys cost of sales:  Cost of Sales = Beginning Inventory + Purchases  Ending Inventory  For example, lets imagine that a company has $15,000 of inventory on hand at the beginning of the month. Throughout the course of the month, the company spent around $5,000 on raw materials, wages, and delivery. With $9,000 worth of inventory at the end of the month, you can use the cost of sales formula to calculate your companys cost of sales during the month:  Cost of Sales = $15,000 + $5,000 - $9,000 = $11,000  Understanding the importance of the cost of sales formula  As you can see, calculating the cost of sales formula is relatively simple, assuming you know what to include and what to leave out of the calculation. Ultimately, knowing how to calculate the cost of sales is necessary for working out your businesss gross profit. Once you know your gross profit, you can determine how effectively youre managing the manufacturing process and how much remaining revenue youll have to deal with other expenses, such as debt. In other words, if you want to understand your businesss financial performance in greater depth, the cost of sales formula is vital. We can help  GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.