Your e-commerce glossary

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What is Cost of Goods Sold?

COGS includes direct costs like materials, labor, and manufacturing for goods sold, helping Shopify owners price products and calculate profit margins.

Explanation

COGS represents the direct costs incurred in the production of goods or services sold by a business. For Shopify merchants, COGS includes expenses like the cost of inventory, raw materials, labor costs, and any costs directly associated with bringing the product to market. It’s subtracted from total revenue to determine the gross profit, providing insight into the profitability of the business. It’s an essential figure for financial analysis and tax reporting.

Importance

  • Profit Margin Calculation: COGS is used to calculate the gross profit margin, helping business owners understand how much they earn after direct expenses.
  • Pricing Strategy: By understanding COGS, merchants can set competitive prices that cover costs while maintaining profitability.
  • Financial Health: Accurate COGS calculation helps determine the financial performance and operational efficiency of the business.
  • Tax Reporting: COGS is a deductible expense on tax returns, reducing the taxable income for the business.

How It Works

  • Inventory Tracking: Calculate the beginning inventory for the period, add purchases of goods, and subtract the ending inventory to get the total cost of goods sold.
  • Formula: COGS=Beginning Inventory+Purchases−Ending Inventory
  • Include Direct Costs: Include costs directly tied to production, such as materials, labor, and manufacturing expenses.
  • Financial Reporting: Use COGS to calculate gross profit and determine the business’s overall profitability.

Benefits

  • Improved Profitability Analysis: Helps merchants track profitability by understanding how much of their revenue is spent on producing goods.
  • Better Decision-Making: Accurate COGS information helps in making decisions about pricing, inventory management, and supplier negotiations.
  • Tax Efficiency: By deducting COGS, Shopify store owners can reduce their taxable income, lowering their overall tax liability.
  • Operational Insights: Identifying fluctuations in COGS can highlight inefficiencies in production or sourcing, offering opportunities for cost reduction.