What are COGS (Cost of Goods Sold) and what role do they play in my bookkeeping?
Most handmade artists need to know and follow this concept, but it is often misunderstood. Using COGS is the most accurate way to account for your business’ financial position. COGS are expenses of the raw materials you have used in your handmade products that have sold throughout the month/year.
For example: You buy $500 worth of raw materials during a month. During that month, you use $300 of those raw materials to make products or finished inventory. During the month, you sell some of those finished inventory items—their retail price is $800 and the raw materials used in those sold finished inventory items is $175 (this is the COGS). First, take your $800 in sales revenue, now subtract your $175 is COGS—this is your gross profit ($625). At the end of the month, you have $200 remaining in raw materials ($500 – $300). You also have some raw materials that have given value to products you have finished, but not yet sold—they are valued at $125 ($300 – $175)—your unsold finished inventory’s COGS value—not their retail value.
There are many benefits to accounting for your COGS:
First, when you make a product, you always know the raw material cost related to your product so you can appropriately price the item.
Second, your financial records are the most accurate and you see the most true financial position and performance of your business. (You really see how profitable your business was during a time period because you have accurately matched the timing of your raw materials usage to the timing of when they generate you money).
Third, COGS is an entire section on Schedule C—a tax form that most handmade artists file as a sole proprietor. When first filing, many small business owners are surprised to find this section are and unfortunately unprepared.
Fourth, by keeping track of COGS throughout the year for every product you make, it also accurately helps you keep track of your raw material values and finished good inventory values. This information is priceless in giving your knowledge to make smart financial decisions that will profit you immediately and in the future. (Do you have too much money tied up in raw materials? Do you need to focus on turning those raw materials into products? Do you have too much money tied up in finished goods? Do you need to focus on turning those finished goods into sales? Do you need to buy more materials because your stocks are low? Do you need to increase your pricing, because your gross profit margin is too small?)
Learn how you can track your cost of goods sold with Handmade Bookkeeping Complete.
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