Cost of Goods Sold (COGS) Meaning in eCommerce

Are you looking to work out your store's COGS? This article defines COGS, why this metric is important, and how to accurately work it out for your store. Plus, find out how you can reduce COGS and start boosting profits today.

What Is COGS?

Cost of goods sold (COGS) is a crucial metric that represents the costs associated with producing or sourcing the products that an online store sells. These can include materials, and labor costs, but excludes indirect costs like rent, utilities, and insurance. COGS can also include products purchased from suppliers, plus costs of producing and storing inventory, such as manufacturing or warehousing expenses.

Why Is COGS Important?

Understanding COGS can be crucial for scaling an online store for a range of reasons. Most importantly, it has a direct impact on profit margins. Accurately calculating the COGS, businesses can determine the true cost of producing or purchasing their products and can set prices that ensure they make a profit. However, pricing products too high can result in lost sales, while pricing them too low can result in falling profits.

COGS is also important in understanding effective product pricing strategies. Knowing the direct cost of inventory can allow you to set prices that offer a competitive advantage, Whilst still making a profit. This can also help you identify areas where your store can reduce costs, such as finding a cheaper supplier or optimizing production processes.

Identifying areas for cost reduction is another key benefit of understanding your store's COGS. Analyzing the components of your COGS, you can identify areas where there is potential overspending and look at tactics to cut back. This can include negotiating with suppliers, optimizing inventory management, streamlining the order fulfillment process, or reducing product returns.

Is Cost of Goods Sold an Expense?

COGS is considered an expense in accounting and can be found on a financial report or income statement. COGS is actually a requirement in the US for tax purposes, as companies that produce or resell goods or services need to calculate COGS in their accounting method as an expense. This will then decrease the amount of taxes they need to pay.

How to Calculate Cost of Goods Sold

Calculating COGS in eCommerce primarily involves tracking inventory costs, plus additional costs and returns. There are some key factors to take into account, broken down below:

Track Inventory Costs

To accurately calculate COGS, businesses need to keep track of the cost of products they purchase from suppliers. Plus, any costs linked with producing or storing products, such as raw materials costs or warehousing expenses. You can do this by manually creating a tracking system or by using inventory management software.

Include Additional Costs

Alongside calculating the costs of goods purchased or produced, there may be additional indirect costs incurred linked to inventory sold. These costs of sales can include shipping fees to your warehouse, packaging costs, and transaction fees. These business expenses should be part of a cost of goods sold formula.

Returns

Operating expenses such as product returns, plus damaged or defective items, are costs that need to be included in COGS. This will ensure that the complete COGS is included for each accounting period for your small business.

Related post: How to Calculate Ending Inventory

How to Find Cost of Goods Sold Fast

You can use a basic formula to find your store's COGS over a given period:

COGS = starting inventory + purchases – ending inventory

This straightforward formula brings together all the direct costs involved in the production or purchase of goods over a given period. This can be months, quarters, years, or even every week or fortnight. Check out a quick breakdown of the formula components below:

1. Starting inventory. Value of your store's inventory from the previous period
2. Purchases. Total cost of your store's purchases over the period under analysis
3. Ending inventory. Value of unsold inventory at the end of that period

To get your store's COGS as accurate as possible, you can use an extended COGS formula that includes returns, freight shipping charges, discounts, and allowances:

COG = starting inventory + purchases + shipping cost – ending inventory – purchase discounts – returns

This more complex formula takes into consideration the cost of shipping to your warehouse, plus any purchase discounts or returns to your supplier. Taking in the wider costs of your supply chain allows you to accurately calculate your store's COGS.

Strategies for Reducing COGS

Reducing COGS for your online store is an ongoing process that requires constant attention and optimization. Below, we break down some actionable strategies that you can use to increase the gross profit of your online store.

1. Negotiating With Suppliers

One of the most effective ways to reduce COGS is to directly negotiate with suppliers to push for better prices. This can include purchasing in bulk, building up a long-term relationship, and comparing prices from a range of different suppliers to find the best deal.

2. Optimizing Inventory Management

Managing inventory effectively can help reduce COGS by minimizing waste and reducing the cost of carrying excess inventory. This can include forecasting demand, setting reorder points, and using just-in-time inventory management systems.

3. Streamlining Order Fulfillment Processes

Improving your store's order fulfillment process can help reduce COGS by minimizing labor costs and improving handling timeline efficiency. This can involve automating order processing, developing SOPs, and outsourcing fulfillment to third-party providers.

4. Reducing Product Returns

Product returns can be a significant cost for your online store. By reducing the number of returns through better product descriptions, customer support, and quality control measures, you can increase gross margin.

5. Reduce Shipping Costs With Easyship

Reducing freight shipping costs from your suppliers can help significantly reduce your COGS. Easyship can help you effortlessly hack shipping costs in just a few simple clicks. Our tech can help you optimize any shipping process for your store.

COGS is a crucial metric for you to understand and manage for your online store. By accurately calculating COGS, you can set prices that boost profit, while identifying areas where you can reduce costs.

Analyzing your COGS regularly can help you continuously optimize and find ways to reduce it. From negotiating with suppliers to streamlining order fulfillment and reducing shipping costs, you can use your COGS to improve profit margins and grow your store today.

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