As an eCommerce business owner (or future eCommerce business owner), you might have already come across the COGS acronym before. It is a vital part of eCommerce accounting, but it’s also something that many beginners do not understand. And even if you have a thriving online retail business, you may not fully grasp what COGS means or how you can put it to use in your accounting processes.
So, what does COGS stand for? Why is it so important? Is COGS only relevant to eCommerce? Finally, how can you calculate COGS without spending hours in front of a spreadsheet?
In today’s guide, we will answer all of these questions and more, so let’s get started!
First, let’s go over a quick bit of accounting grammar. While it can be tempting to talk about COGS as something plural, it actually refers to a singular thing. More specifically, COGS is an acronym that stands for “Cost of Goods Sold.” This is why we are asking what COGS is (not what COGS are).
As the name implies, COGS is a term used in bookkeeping and accounting to discuss the costs associated with producing or acquiring products that your business has sold. The components that go into COGS can vary from one business to the next. That said, you’ll often need to consider all of the following costs when calculating COGS:
● Manufacturing or acquisition, including the cost of raw materials
● Overhead (specifically overhead required in attaining the final product)
Keep in mind that COGS does not refer to the cost of procuring just one unit, though this is a very important part of understanding COGS. Instead, COGS can be understood as the total cost of the goods you have sold. Or, to put it another way, all of the costs that go into the products that have actually been purchased by consumers.
So why do you, as an eCommerce business owner, need to know your COGS? Because it’s the only way to actually know how much money you’re making. Whenever you sell a product, there are certain costs that your business naturally incurs to either produce or acquire that product. If you don’t fully understand that cost, you have no way of knowing your real profits.
Let’s say that you sell tennis shoes. If you’re only thinking about the price it costs you to acquire each pair of shoes, you won’t be able to price them in a way that’s actually profitable for your business.
You have to think about a myriad of other factors that go into operating your business in relation to each pair of shoes. Do you have to pay employees who play a role in the acquisition, sale, or shipping of the shoes? If so, how do you factor the cost of labor into your COGS calculation? What about business overhead? Do you have to store the shoes somewhere? Do you have to pay for office space, utilities, or other costs to maintain your business? Finally, how do you get the shoes from the warehouse to the customer? Do you ship them yourself or do you outsource the shipping to another company? In either case, do you know how much it’s costing you to ship each pair of shoes? If you can’t answer these kinds of questions, you won’t be able to price your products correctly to ensure that you make a healthy profit.
Traditional, brick-and-mortar businesses often have a more straightforward process for knowing and understanding the cost of goods sold. For example, a traditional business that makes its own products will simply need to add all of the aforementioned factors together and come out with a number that shows the total cost. Then, this figure can be used to calculate profits. While it still takes a bit of math and a deep understanding of all the business’s expenses, it is pretty cut and dry.
Things aren’t quite as simple for eCommerce, as there are often very specific costs related to running an online business. Here are just a few of the items you’ll need to consider when calculating the COGS for your eCommerce store:
● Packaging, Shipping, and Fulfillment Costs - Many traditional businesses have to think about fulfillment costs as well, but as an online retail store, it is something that is factored into every product you sell. For example, if you’re shipping your own products, you’ll need to consider the costs of packaging (boxes, labels, packing materials, etc) as well as the costs of shipping with a logistics company like UPS or FedEx. Alternatively, if you use a fulfillment program like Amazon FBA, you’ll need to factor in the costs of storing, packaging, and shipping products that you pay to the company that handles these processes for you. If you pay to insure your shipments, this will also need to be added to your COGS calculation.
● Return Costs - Again, any business that sells products and allows for returns will need to factor return costs into its COGS calculations. However, eCommerce businesses often have very different expenses related to returns, as well as a higher volume of returns compared to brick-and-mortar shops (though this varies by industry and the type of products being sold). If the fulfillment process is outsourced, you may need to pay restocking fees to the third-party company. To make things more complicated, you will need to include the cost of any items that are returned in an unsellable condition. Finally, depending on how you manage shipments and the conditions of your return policy, you may have to reimburse customers for their return shipping costs.
● Digital Promotions - These days, many eCommerce businesses boost sales by running promotions and discounts, often in the form of coupon codes used at checkout. You will need to consider these promotions when calculating COGS, as they act as an extra expense for your business. Sure, they may help boost sales, but they also artificially increase the cost of goods sold by decreasing the sales price.
● Platform Expenses - Whether you host your eCommerce website or you sell through a platform like Shopify, you’re going to incur a variety of fees, transactional expenses, and maintenance costs. You’ll need to factor in these costs, as well as the costs of any other software that is directly related to the manufacture or acquisition of goods.
Once you know the costs that go into your products, calculating COGS is pretty simple. To calculate COGS for your eCommerce business, simply follow these steps:
● Pick a Time Period - Whether you want to calculate your COGS for the year or for the month, you need to decide what time period you want to focus on.
● Identify Your Opening Inventory - Starting from the beginning of your chosen accounting period, determine the value of items in your inventory.
● Add Additional Inventory Costs - Calculate how much your business spent producing or acquiring new inventory over the designated accounting period. Then, add it to the value of your opening inventory.
● Subtract Your Closing Inventory - Finally, take the sum of your opening inventory and any additional inventory costs you have and subtract the value of your closing inventory (i.e. the value of your inventory at the end of the accounting period).
The only way to really know your gross profit is to subtract your COGS from your total revenue. From there, you can calculate your net profit by seeing how much you’re left with after paying all of your necessary business expenses. Needless to say, all of the calculations related to COGS and profits require accurate data that is well-organized. If you’re still using Excel spreadsheets and manual data entry, you may have a hard time even beginning to understand the profitability of your business.
Fortunately, ConnectBooks can provide you with the information you need in seconds. Not only can ConnectBooks integrate sales data from multiple sales channels, generate reports based on your expenses and sales, and help you calculate COGS with ease, but it can also automate data integration to save you time and money. If you want to understand how much your eCommerce business is making without staring at the numbers for hours on end, let ConnectBooks do the hard work for you.
Do you want to learn more about calculating COGS in eCommerce accounting? If so, reach out to the experts at ConnectBooks today!