Today we will learn what the cost of sales is and how to calculate it so that you have the information you need about the financial health of your business.
Factors such as cash flow are vital for all small businesses, but if you do not understand the internal movement of capital in your company, cash flow becomes extremely difficult to manage. That’s why it’s so important to know how to calculate cost of sales.
What is cost of sales?
Cost of sales shows how much a retail or wholesale company spends on the products it buys from suppliers for resale.
The cost appears as a direct cost on the income statement. It is only used by companies that do not manufacture their own products (manufacturing companies measure direct costs, the cost of goods sold, differently, indicating how much they spend to make their products).
Managers use cost of sales to assign a value to inventory units. As a percentage of revenue, cost determines the efficiency of purchasing.
What is cost of sales used for?
Many companies that sell products use cost of sales to accurately calculate their gross margin. The money spent to initially create or purchase the product is compared to the money earned in the final transaction. The difference is the gross margin.
How to calculate the cost of your sales
The various costs of sales fall into the general subcategories of direct labor, direct materials, and overhead, and can also be considered to include the cost of commissions associated with a sale. The cost is calculated as beginning inventory + purchases – ending inventory.
The cost of sales does not include general and administrative expenses. It also does not include the costs of the sales and marketing department.
What can be included in the cost of sales calculation?
One of the main points of costing is knowing which expenses should be included and which should not. If a certain expense is stopped being paid and the products or service can continue to be manufactured, that expense should not be included in the cost of sales formula.
However, if failing to pay a specific expense could cause production to stop, it should be included in the calculation. These are some of the expenses that should be included:
- Software licenses
- Raw materials or supplies needed for production
- Product packaging cost
- Storage cost of products/materials
- Salaries of employees involved in the direct manufacturing/delivery of goods and services