Table of Contents
- 1 What Is the Cost of Goods Sold?
- 2 What Does Cost of Goods Sold Include?
- 3 Why Is COGS Important?
- 4 What Is COGS In Accounting?
- 5 The Two Accounting Methods of Calculating COGS
- 6 Inventory Valuation Methods
- 7 Wrap Up
In fact, when selling on Amazon, always keep in mind that your business’s ultimate goal is, typically, making a net profit. This is why the majority of merchants start selling.
To be in the black figures you should know your cost of sales. In your accountancy, a financial concept of Amazon Cost of goods sold (COGS for short) helps you do so. A lot of sellers think of it as a headache. However, financials are an integral part of every business.
Not only does COGS help you set the right price for your products since it’s an expense. It also shows the overall financial health of your business. In addition, it provides for effective tax management and indicates how much you can invest in growing your sales.
Read further to get to know what is Cost of goods sold explained in simple terms and how to calculate the cost of sales on Amazon.
What Is the Cost of Goods Sold?
Cost of goods sold is an accounting term that indicates the expenses for the manufacturing and sale of a product. To clarify, it’s costs related to selling your products on Amazon.
For instance, if you are a retail or online arbitrage seller, Cost of goods sold will include wholesale prices you’ve paid for inventory. In addition, transportation fees and other relevant expenses until you receive the product are also COGS.
In fact, Amazon COGS is an expense. It is an accounting principle that helps match the cost of an ASIN and its sale. COGS shows your revenue and profitability in a specific month.
In the sale price of a product, COGS is the major part of the money you spend on it. Roughly, the rest is your profit margin. Because the Cost of goods sold is deducted from the sale price, the higher the COGS, the lower the profit margin.
Therefore, knowing Amazon cost of goods sold helps you better manage inventory. You can see what’s profitable and what’s not.
COGS Amazon example
Say, a private label merchant purchases 150 pullovers from Alibaba manufacturer in China. They spend $15 per unit (including shipping, import fees, and other costs of bringing the products into the U.S).
The total investment before you list pullovers is $2,250 before profit.
The $15 you’ve paid per unit (not including marketing, salary, and similar costs), refers to COGS.
Amazon requires FBA sellers to list products with a sale price of at least 10% higher than their COGS.
Note: The value of COGS may vary depending on the accounting method you apply.
What Does Cost of Goods Sold Include?
Basically, COGS comprises the costs related to the ASIN’s production and does not include overhead costs. COGS expense includes direct and indirect costs.
The direct costs are expenses for inventory manufacturing.
These are the expenses necessary to sell your products.
- fulfillment fees, storage fees, and taxes and duties.
- storage fees and costs;
- shipping costs;
- taxes and duties;
- listing fees.
Note: COGS doesn’t include certain operating expenses (OPEX). These are utilities, payroll, office rent, and accounting fees.
Why Is COGS Important?
Since COGS is an expense, it helps you monitor your revenues, gross margins, and profitability in a given month. Accounting for the cost of goods sold gives more accurate control over the inventory. It is used to recognize the most profitable products, develop a competitive pricing strategy, and control inventory costs.
Figuring out the most profitable ASINs
COGS is the component of your sale price. Therefore, the higher the COGS, the lower the profit. By tracking the Cost of goods sold, you can pick out the most profitable items and adjust your marketing campaigns to advertise these ASINs. On the other hand, you should look into your strategies with the items that bring low profit.
Developing a competitive pricing strategy
As far as COGS is a cost of doing business, this metric helps sellers estimate their bottom line. If COGS is high, net income is low, and the business will generate less profit.
You can adjust your price compared to the competition without making red figures. At the same time, you’ll ensure that you cover your expenses.
Controlling inventory costs
COGS helps you be savvy with regard to your inventory. It’s important to keep your COGS low to generate a higher profit. Also, it helps determine inventory expenses for tax reporting. You should see what you address as COGS since it lowers your taxes.
What Is COGS In Accounting?
Generally, accountants calculate COGS by the formula.
Formula for accounting
A seller purchased inventory for $20,000 at the beginning of the year and an additional inventory of $10,000 3 months later. At the end of the year, the leftover inventory is for $3,000.
Your COGS is, therefore = $20,000 + $10,000 – $3,000 = $27,000
If you produce your inventory, the U.S. Internal Revenue Service (IRS) recommends you apply the formula below.
COGS = (Inventory at the beginning of the year + net purchases + cost of labor + materials and supplies + other costs) – inventory at the end of the year
The Two Accounting Methods of Calculating COGS
In accounting, there are two ways of calculating the Cost of goods sold – cash basis accounting and accrual accounting.
Cash basis accounting
This method is the simplest way to account for revenues and expenses. It recognizes the inventory the moment you purchase or receive it.
For instance, if you’ve paid the supplier $10,000 for 1000 T-shirts, you recognize the expense immediately.
The majority of the sellers use this method due to its simplicity. However, it’s not very accurate when accounting for profits.
With this method, you recognize payments and expenses when a transaction happens rather than when you receive payment. To clarify, you should recognize expenses and revenues in the same reporting period.
In practice, that means that you account for your orders as an inventory asset and expense the units when you sell them.
For instance, you purchased 1000 T-shirts in March but they start selling in May. In such a case, you account for the money you paid for the inventory as an expense in May.
Some sellers use this method since it accounts for the revenues more accurately.
Inventory Valuation Methods
The value of COGS depends on the inventory costing method you apply. There are three methods to account for the inventory you sell over a period: First In, First Out (FIFO), Last In, First Out (LIFO), and the Average Cost Method.
First-In, First-Out (FIFO)
With this method, you assume the oldest units of inventory are always sold first.
To figure out COGS using FIFO, you should get the cost per unit of your oldest inventory and multiply that cost by the number of inventory sold.
Last-In, First-Out (LIFO)
This is the opposite approach. You assume that you sell the newest inventory before the oldest.
To determine COGS using LIFO, you should take the cost of your most recent inventory and multiply that by the number of inventory sold.
Average Cost Method
Here, you use the average price of all the goods in stock, regardless of purchase date, to value the goods sold.
You should use this method to compute the average cost of each product you purchased over a particular period of time. Then apply that figure to calculate the Cost of goods sold by formula.
Making black figures is important. It shows how healthy your Amazon business is. To understand your expenses and revenues better, you should know your cost of sales. For that, in accountancy, there is a financial concept of Amazon Сost of goods sold. It helps you develop the right price strategy, control your inventory costs, and grow your business without overspending.
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