As part of our ‘Understanding Accountancy Terms’ series, we cover common terms you might find when running your own business. This time, we’re explaining the term ‘cost of sales’ – also known as ‘cost of goods sold’, or COGS for short.
What does ‘Cost of Sales’ mean?
Cost of sales or ‘cost of goods sold’ refers to how much it costs a business to make a sale. These are different to expenses, which don’t directly relate to individual sales like COGS do. An example of an expense might be office rental charges.
What kind of things should I include when working out the cost of sales?
The cost of a sale might include how much it costs to pay for :
raw materials to make products
materials for a builder
subcontractors carrying out the core service on offer
You should include these, even if you don’t actually pay for those costs at the same time as making the sale.
Why is the cost of sales important?
The amount of money that it costs to produce products or sell services to your customers eats into amount of profit that you can make.
Knowing how much you have spent on making a sale will help you understand how efficiently the business operates, or where the business needs more attention.
It’s also a key part of understanding gross profit:
sales – cost of sales = gross profit
Gross profit as a percentage is important to understand because it will indicate if your pricing is correct. For example, retailers typically have a 50% to 70% gross profit margin. If a retail business owner only has a 20% margin, then either their costs of sales are too expensive, or they’re not charging enough.
That’s why it’s so important to keep thorough records of everything you’re buying and selling through your business, so that your figures are accurate. Having items incorrectly categorised can affect your calculation for costs of sales, which will lead to misunderstandings when looking at your gross profit margin. Accurate bookkeeping can save you a lot of money!