Man checking inventory with a handheld device.
The cost of goods sold (COGS) is a component of the value of a company’s inventory. Inventory and cost of goods sold are directly dependent on practice and books. In practice, a company cannot have inventory without also having proportional costs that allowed it to generate that inventory. In accounting, COGS is subtracted from revenue to establish gross margin, that is, the amount of profit made from the sale of the company’s inventories.
COGS is an expense category that collects all the direct costs incurred to produce and sell a company’s products, or the direct costs of converting inputs into revenue. Depending on the type of business being studied, the relationship between inventory and cost of goods sold can be more or less complicated. For example, for a manufacturing company, this includes the cost of raw materials, the direct labor costs to produce the goods, the proportion of setup costs that can be directly attributed to the manufacturing process, and the direct cost of manufacturing. the sales used to sell the goods.
However, in a retail business, COGS is simply the cost of buying inventory from a wholesaler or manufacturer, the cost of preparing it for sale, and the cost of selling it. The relationship between the two in a manufacturing environment is a bit more complex. It is usually easier in a retail environment to segment the appropriate costs that should be assigned to the COGS category.
The most relevant connection between inventory and COGS is how the two relate to establishing a company’s profitability. Revenue is the amount of money a company receives as a result of the sale of its products. This number is important, but it does not reflect whether the company is making or losing money. Profitability can only be determined when the business owner subtracts the costs incurred to generate that revenue.
At the most basic level, a business needs to know its gross margin, or the profit it makes from turning its inventory, before considering additional expenses like taxes. To calculate this, the cost of producing and selling the inventory, or COGS, is subtracted from revenue. Inventory and cost of goods sold are inextricably linked in this analysis because using the value of these two categories exposes basic business facts, such as whether an owner is pricing his products for sale at a level that will earn him a profit. gain.