What is Cost of Sales?
Cost of Sales Definition
The direct costs of creating or purchasing a good sold to a client gets represented by the cost of sales. This figure gets used to calculate a company’s gross margin.
Cost of sales is another term for cost of goods sold (COGS). It is a metric used to determine the cost incurred in producing the goods or services for the end-user to buy.
What is included in the cost of sales?
One of the most common questions about the cost of sales calculation is, ‘which expenses should get included and which should not.’
Suppose you stop paying for a given expense but still have the ability to make goods or provide services. In that case, that expense should not get included in your cost of sales formula.
If not paying for a given expense might bring production to a halt, it should factor into your calculations. Here are some of the costs that you must consider:
- Licensing of software
- Supplies or raw materials required for the manufacture
- Packaging costs for items
- Storage costs for items and materials
- Salaries for people working directly in the manufacturing and distributing goods and services.
How to calculate cost of sales?
Cost of sales formula:
The general formula for computing cost of goods sold is as follows:
COS = Beginning Inventory + Purchases – Ending inventory
Let’s say a business has $5,000 in inventory at the start of the month. The company spent roughly $5,000 on raw goods, salaries, and delivery.
You may utilize the cost of sales formula to estimate your company’s cost of sales during the month if you have $2,000 in inventory at the end of the month:
$5,000 + $5,000 – $2,000 = $8,000
Calculating cost of sales formula is relatively straightforward. That is once you understand what to include and exclude from the equation.
But what’s the point of spending so much time examining sales costs? Recognizing how to calculate the cost of sales is essential for calculating your company’s gross profit.
Once you recognize your gross profit, you can evaluate how well you operate the production process and how much remaining income you’ll have to manage with other expenses. For example, how you manage debt.
In other words, the cost of sales formula is critical if you want to successfully comprehend your company’s finances.
Cost of sales vs. cost of goods sold
While some businesses only report COGS or cost of sales on their balance sheets, others report both. Because you use them frequently interchangeably, it can be difficult to tell how they’re different.
While both cover all direct expenditures associated with a company’s goods and services, there are vital distinctions:
Cost of sales examines the direct and indirect expenses of selling a company’s goods and services. In contrast, COGS looks at the direct costs of manufacturing a company’s items.
Location of the income statement:
On an income statement, cost of sales comes before EBIT margin (operating earnings over operating sales). COGS comes after revenue because it contains all direct costs related to generating revenue.
When both are employed, COGS is always smaller than cost of sales. It is because cost of sales includes other charges whereas COGS concentrates on a company’s direct costs.
The COGS calculation shows the number of things a company creates. In contrast, the cost of sales calculation indicates the number of goods sold.
Reduction of taxes:
While the cost of sales isn’t deductible, you can subtract COGS from gross receipts to calculate a company’s annual gross profit. Claim COGS and other business expenses to boost tax deductions while limiting profit.
What are examples of cost of sales?
Cost of Sales Illustrations:
Example 1: A business starts the month with $10,000 in inventory, spends $25,000 on various inventory products, and concludes the month with $8,000 in inventory. During the month, what was the cost of sales? The solution is as follows:
Beginning inventory? $10,000 + Purchases —>25,000 – Ending inventory —>8,000 = Cost of sales —> $27,000
Example 2: Assume your small business spent $1,000 on finished items in its initial inventory and $2,000 on goods creation throughout the current accounting quarter. If the products cost of your closing inventory is $1,500, then your cost of sales is $1,000 + $2,000 – $1,500 = $1,500.
Cost of sales is a part of a larger domain of expenses. The cost of sales accounts for only the production costs of goods (or services) sold. Expenses include all the costs required to run the business.
Cost of sales helps determine the net profit and keep track of the product’s performance in the market.
COS is a business expense on the income statement since it is a cost of doing business.