How to Calculate the Cost of Sales in Accounts

One crucial number that every small business owner needs to understand is the cost of sales (COS) also known as the Cost of Goods Sold (COGS). This figure represents the direct costs of producing or acquiring the goods or services you sell. By grasping how to calculate and interpret your cost of sales, you gain valuable insights into your profitability, pricing strategies, and overall financial health.

So, whether you’re a seasoned entrepreneur or just starting your business journey, join us as we break down this essential metric in a clear and concise manner. By the end of this post, you’ll be equipped with the knowledge to master your cost of sales and make informed decisions that propel your business forward.

We have provided a Cost of Sales calculator at the end of the page. It allows you to enter your figures and will calculate the stock, COS and gross profit.

Cost of Sales on Profitability

The cost of sales directly affects your profitability because it’s the primary expense deducted from your revenue to calculate your gross profit. The formula is simple:

Revenue – Cost of Sales = Gross Profit

This means:

• Higher Cost of Sales = Lower Gross Profit: If your cost of sales is high relative to your revenue, your gross profit shrinks. This leaves less money available to cover operating expenses (rent, salaries, marketing) and contribute to net profit.
• Lower Cost of Sales = Higher Gross Profit: If you manage to keep your cost of sales low while maintaining your revenue, your gross profit will be higher, leading to greater potential for overall profitability.

Think of it like this: Every pound you spend on producing or acquiring the goods you sell directly reduces the potential profit you can make from that sale. Therefore, effectively managing and controlling your cost of sales is crucial for maximizing your business’s financial success.

Stock vs Inventory

While the terms “stock” and “inventory” are often used interchangeably, there is a subtle difference between them, especially in a business context:

Stock

Stock refers specifically to finished goods that a company has available for sale. It might either be goods purchased for direct resale or items that a business has produced.

Inventory

Inventory refers to finished goods, raw materials and work-in-progress. Raw materials are the components used to manufacture the goods. Work in progress are products that are in the process of being manufactured.

Cost of Sales Formula and Example

To calculate the actual cost of the goods sold, you must complete the following calculation.

Beginning Inventory + Plus Purchases – Ending Inventory = Cost of Goods Sold

An example is a business that has a beginning Inventory of 5000.00; during the year, it purchases 3000.00, and at the end of the year, the ending inventory is 4000.000

The figures would be as follows:

5000.00 + 3000.00 – 4000.00 = 4000.00 Inventory Sold or Cost of Goods Sold.

Direct Costs

There are other costs which are also classed as direct costs of selling a product or service. Direct costs are expenses that can be specifically and easily traced to the production of a particular product or service. They are the core components that go into making your product or delivering your service.

Examples of Direct Costs

Direct Materials: The raw materials, components, and parts that are physically incorporated into the finished product.

• For a bakery, this would include flour, sugar, eggs, etc.
• For a furniture maker, it would be wood, nails, screws, fabric.

Direct Labor: The wages, salaries, and benefits paid to employees who are directly involved in the production process.

• Assembly line workers in a factory
• Bakers and pastry chefs in a bakery
• Carpenters and upholsterers in a furniture workshop

In the example used above, we can include wages for manufacturing the product of 1000.00, a commission of 500.00 and delivery charges of 50.00. The profit and loss or income statement will now look like this:

Indirect Costs

Indirect costs are expenses that cannot be directly linked to a specific product or service. These costs are not easily traceable and can include things like utilities, rent and insurance for a factory or production space. They can also include packaging and shipping costs.

Inventory Management

Inventory management is an essential part of any business, big or small. It involves keeping track of the goods and materials that a company has in stock, as well as monitoring the flow of these items from supplier to customer.

One of the main goals of inventory management is to strike a balance between having enough stock to meet customer demand while also minimising excess inventory. This requires careful planning and organisation to ensure that a business does not run out of important products or incur unnecessary costs.

Inventory management is important in Cost of Sales as too much inventory can lead to high storage costs, insurance and possible write off of raw materials that are out of date or old products. Having not enough will mean not meeting demand and fulfilling customer orders.

Cost of Sales Accounting

If you use an accounting software package that tracks stock, once the purchase and sales invoices are allocated to the correct stock code, it will complete the calculation. An example is a business that sells a computer which allocates a stock code of 134.

The business orders stock of 4 computers in March at 300.00 each; the figure would be posted to the stock asset on the balance sheet.

If you are using a manual system, you will need to make the necessary adjustments. 

In April, it sells two computers at 500.00 each; the reports would then be as follows:

The profit and loss account would then show:

Cost of Sales Calculator

We have designed two calculators. The first will calculate the cost of goods sold, and the second will calculate the gross profit and percentage.

Cost of Goods Sold Calculator

To use this tool, enter the figure for opening stock, purchases for the year and closing stock. The figure will automatically be calculated for you.

Gross Profit Calculator

This calculator will work out the total net profit, gross profit and gross profit percentage of sales.  To use the calculator, enter the figures for sales, cost of sales and business expenses. Business expenses include all other costs which are not included in the cost of sales. Additional costs include utilities, wages, post, rent and general expenses. 

You can use our Profit and Loss template if you need to record all the business expenses to get a total.

Further reading can be found on the Accounting Coach website.

Return from Cost of Sales to Profit and Loss Statement.