Forget about salaries, rent, utilities, or even the amount of tax you reluctantly pay to the IRS. If there’s an expense item you need to track with laser precision, it’ll have to be your cost of goods sold.
Accurate tracking of the cost of goods sold will —
- help you correctly price your product,
- help you know your cash flow needs,
- help you know your optimal inventory levels, and
- help you know your Gross profit. This is because Gross profit is sales minus the cost of goods sold.
But what exactly is the cost of goods sold, and how can you track it in an ecommerce business?
Let’s dive in.
What is the Cost of Goods Sold?
The cost of goods sold is not the cost of products you’ve bought. Instead— as the name implies — the cost of goods sold is the cost of the products you’ve sold.
And there’s a big difference.
Here’s why.
If you’re selling laptops, you may have used $100,000 to buy all the laptops you wanted to sell throughout the year. However, the sun will set on Jan 31 when you still have some laptops in your inventory. These unsold laptops should not make up your cost of goods sold — because you didn’t sell them.
So yes. As the name suggests, the cost of goods sold is the cost of products you sold.
How To Calculate Cost of Goods Sold for Ecommerce
Calculating the cost of goods sold will depend on the ecommerce business you’re engaged in.
Generally, all businesses worldwide fall into one of the following three categories.
- Merchandise business: These businesses only sell finished products: laptops, clothes, jewelry, name it. A good example is Shein, a renowned fashion retailer selling only on its ecommerce platform.
- Manufacturing business: These businesses make or manufacture the products they sell. A fine example is the Georgia-based Cleaver-Brooks, which makes various boiler room products and sells them through the Optimizely ecommerce platform.
- Service businesses. As the name implies, these businesses offer services — not tangible products. A good example is Cleanly, a popular home cleaning business you may want to think of as the Uber of laundry.
Since service-based businesses do not deal in physical goods, their financial reports rarely include the cost of goods sold.
On the other hand, determining the cost of goods sold for manufacturing entities is a more complex affair that involves calculating the cost of raw materials, direct labor hours, and manufacturing overheads.
Therefore, we’ll do a deep-dive on determining the cost of goods sold for merchandise businesses.
How To Calculate the Cost of Goods Sold Merchandise for Ecommerce Businesses
To determine the cost of goods sold, you take the cost of purchases you’ve made and subtract the cost of the products that have remained unsold at the end of the year.
Hence, Cost of Goods Sold (COGS) = Cost of Purchases – Cost of Closing stock.
The above formula especially applies to an ecommerce business in its first year of operation.
However, you’ll need to make a slight adjustment for a continuing business.
This is because continuing businesses don’t often start on an open slate. Usually, there’s some unsold inventory from the previous period that you’ll want to sell during the currency year.
Because of this, the formula for calculating the cost of goods sold for a continuing business is as follows:
Cost of Goods Sold (COGS) = Cost of Opening Inventory + Cost of Purchases – Cost of Closing stock.
Let’s now jump to the actual steps of calculating the cost of goods sold.
Step 1:Laying the Foundation and Putting Everything in Place
Using a cost of goods template, you’ll need to go to the “Set-up Table” and map all the individual items you’re selling. This involves —
- Specifying the financial period
- Assigning a consistent name to each of your inventory items and
- Assigning a unique identifier or a code to each of your inventory items.
If yours is a continuing business, you’ll need to also include—
- A list of all the items that constitute your beginning inventory
- The initial quantity of each item of the beginning inventory and
- And cost per unit of each item of the beginning inventory
Step 2: Entering Information Related to Purchases Made During the Year
After setting up, it’ll be time to enter information related to all your purchases during the year. To do this, you’ll go to the “Purchase Table” in the template and —
- Enter the purchase date: This is when you purchased an item, as reflected on the individual invoice.
- Enter the purchase order number: While this is optional, establishing a paper trail for all your inventory items is a crucial internal control practice. Otherwise, there’s a risk your business may make a purchase that wasn’t properly ordered.
- Enter the quantity purchased for each item
- Fill in the cost per unit for each item purchased.
Step 3: Entering Information Related to the Sales Made During the Year
After filling out the “Purchases Table,” proceed to the “Sales Table and —
- Enter the date of each sale as captured in the invoice.
- Enter the quantity of each item sold.
Step 4: Establish the Cost of Goods Sold
The final step is establishing the cost of goods sold, which the template should calculate automatically.
COGS for Ecommerce: Wrapping It Up
Without knowing your cost of goods, you may miscalculate your Gross profit, misprice your products, and make terrible inventory decisions.
Of course, determining the cost of goods sold should be easy. You take the cost of opening inventory (if any), add the cost of purchases, and then subtract the cost of closing inventory.
But make no mistake. It can also get quite complex, especially when dealing with many products.
At Equivion, we can help you understand your numbers (including your cost of goods sold) — ensure you gain clarity on your business financials— and know when to expand, invest in, cut back, or grow.
Ready to join the more than 80 ecommerce clients we serve every month? Let’s chat.
