The formula for calculating COGS is the sum of the initial inventory plus net purchases minus net purchases/addition to stock. To calculate it you can follow the three steps to calculate COGS: the initial inventory of merchandise, total net purchases, and then the Cost of Goods Sold. Come on, read the full explanation in this article.
How many COGS elements are there?
There are three elements of COGS: the beginning inventory of merchandise, stock additions or net purchases, and ending inventory. Here’s the explanation:
1. Beginning Merchandise Inventory
Initial merchandise inventory is the amount of stock still available at the beginning of a certain period, for example, at the beginning of the year.
2. Stock Additions or Net Purchases
Stock additions or net purchases are purchases of merchandise to add stock whose nominal value includes the costs of obtaining these items.
For example, the cost of goods has been reduced by discounts/promos, then added by packaging costs, shipping costs, and so on.
There are several elements in net purchases, including price reductions (discounts, promotions, buy one get one free), gross purchases, purchase discounts, and purchase returns.
3. Ending Merchandise Inventory
Ending inventory is the inventory remaining at the end of a period, for example, at the end of the year. In this case, the amount has been reduced by the returned goods if any of the goods are damaged.
The ending inventory count includes gross purchases, price reductions, and purchase returns.
Costs Not Included in the COGS Calculation
Apart from knowing the various costs that you must calculate in the COGS, you also need to know some of the components or costs that are excluded and not included in the calculation of the Cost of Goods Sold, namely:
- Administration costs include advertising, rent for business premises, shipping costs from the business location to the buyer, employee salaries, and other administrative costs.
- Non-operational costs, such as loan interest.
- Costs for unsold products, including costs for product storage or rental of storage space.
When is COGS Calculated?
If you are starting a business, you must calculate the COGS before the business operates and sells goods. Meanwhile, if the business is already running, it’s a good idea to calculate the COGS at the beginning of the booking period or each year.
During this period, there might be changes in the price of capital goods, increases in the cost of shipping goods, and so on.
3 Steps to Calculate COGS and the COGS Formula
Step 1: Compute the Beginning Merchandise Inventory
You already know that the initial inventory means the exclusive merchandise you already have and is ready to sell. So, to sell a product, you must first know the COGS and then determine the selling price of the product.
The formula for calculating the beginning inventory:
Initial Inventory = (Product Price – purchase discounts – item returns) + Costs.
Example of how to calculate beginning inventory:
- Purchases of merchandise products: IDR 52,000,000-
- Purchase discount: IDR 2,000,000-
- Purchase returns: IDR 5,000,000-
- Packaging Fee: IDR 2,000,000-
- Fee for sending goods to the warehouse: IDR 2,000,000-
I am beginning Inventory = (Product Price – purchase discounts – goods returns) + Costs.
= (52,000,000-2,000,000-5,000,000)+(2,000,000+2,000,000)
= 45,000,000 + 4,000,000
= 49,000,000
Then the total initial inventory = IDR 49,000,000-
Step 2: How to Calculate COGS for Net Purchases/Inventory Additions
In this second step, you must calculate the total purchase of merchandise you made to increase stock. In it, not only the product capital price that must be calculated but costs directly related to the product must also be considered.
If not, you may experience losses due to costs you don’t count as COGS. So, to avoid business losses, do the calculation using the COGS formula for net purchases:
Net Purchases = (Total Cash and Credit Purchases + Packaging Fees + Transportation Fees At Purchase + Freight Fees) – (Discounts/Promotions + Purchase Returns If Any)
An example of calculating net purchases:
- Purchase of products in cash: IDR 10,000,000,-
- Purchase of products on credit: IDR 20,000,000,-
- Packaging fee: IDR 1,000,000,-
- Transportation Fee: IDR 500,000,-
- Freight Fee: IDR 500,000,-
- Discount/Price Cut: IDR 2,000,000-
- Purchase Returns: IDR 3,000,000,-
Net Purchases = (Total Cash and Credit Purchases + Packaging Fees + Transportation Fees When Purchased + Freight Fees) – (Discounts/Promotions + Purchase Returns, if any)
= (10,000,000 + 20,000,000 + 1,000,000 + 500,000 + 500,000) – (2,000,000 – 3,000,000)
= 32,000,000 – 5,000,000
= 27,000,000
So, net purchases or additions to the stock of merchandise amounting to IDR 27,000,000
Step 3: COGS Formula for Calculating Cost of Goods Sold
After all the COGS components have been calculated, the final step is calculating the cost of goods sold (COGS).
COGS formula:
Cost of Goods Sold = (Beginning Inventory + Net Purchases) – Ending Goods Inventory
In the previous calculation, you already know that:
- Total initial inventory of goods Rp.49,000,000,-
- Total net purchases IDR 27,000,000,-
You also already know that at the end of the period, the remaining stock or ending inventory is IDR 5,000,000
Then how to calculate COGS, as follows:
Cost of Goods Sold = (Beginning Inventory + Net Purchases) – Ending Goods Inventory
= (49,000,000 + 27,000,000) – 5,000,000
= 71,000,000,-
So Cost of Goods Sold (COGS) = IDR 71,000,000
How easy is it to calculate COGS for a retail business? The note you need to pay attention to is that the above calculation applies to finding out the COGS of one product type. Later, you have to divide the known COGS by the number of goods to know the COGS price or the price of capital goods per unit. How do you calculate the COGS for a manufacturing business? You can find out more in this article: How to Calculate Cost of Goods Sold (COGS) for a Manufacturing Business.
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