Accounting terms like “cost of sales,” “price of sales,” and “gross profit” make your head swim, don’t they?
There’s no need to worry. We’ll help you clarify one of these terms: “cost of sales” (COS). After reading this article, you’ll be able to answer questions such as: What is the cost of sales? Is there a cost of sales formula or specific calculation?
This comprehensive article tackles how having working knowledge of the cost of sales keeps a lid on costs to increase profits. You’ll readily see that implementing proven techniques to grow your business actually works. In addition to keeping your costs lean to increase profit, there are other ways you can increase the bottom line, so your business stays on track and thrives.
Before addressing those proven methods to help make your business profitable, let’s find out what’s so important about this accounting term, cost of sales.
What is the Cost of Sales?
“Cost of sales” (COS), also known as “cost of revenue,” and “cost of goods sold” (COGS) consists primarily of variable costs that increase and decrease depending on production levels. All you need to remember is that your gross profit is determined by subtracting COS from your total revenues.
Is cost of sales an expense?
Yes, cost of sales is an expense, and it tends to be the most substantial expense of a business.
As a point of reference, the term cost of sales (COS) or costs of goods sold (COGS) appear on your income financial statement. If you’re like most business owners, you’ll look at your gross profit or profit margin before fixed costs. That’s an important number, but it’s good to know how the cost of sales factors into calculating gross profit.
There’s a simple way to calculate the cost of sales using a basic formula that’s easy to use.
How Do You Calculate Cost of Sales? Cost of Sales Formula
Use the following cost of sales formula that includes specific components to calculate gross profit.
Cost Of Sales = Beginning Inventory + Purchases – Ending inventory
Here’s a simple cost of sales example: Your beginning inventory is $25,000, your purchases are $20,000, and your ending inventory of $15,000. The formula would then look like this:
COS = $25,000 + $20,000 – $15,000
Using the formula, you’d conclude that your COS comes to a total of $30,000.
Elements Included to Calculate Cost of Sales
The inventory at the end of your accounting year is the same figure you use to begin a new year. Many businesses depend on a software program for beginning and ending inventory amounts. It’s a good idea to set aside some time and tabulate product counts manually to verify totals.
At the end of 12 months of production, the inventory number represents purchases you’ve made to sell your products, raw materials, and related supplies, payments to employees who worked directly on producing products, shipping costs, and utilities incurred during the production process.
Rent that you pay to use a facility to manufacture products is also included.
Why the Cost of Sales is Important
Tracking sales and production expenses accurately ensures that your business is operating profitably and at a reasonable cost. By knowing how much profit you make at any given time, you’re in a better position to drop products that don’t perform and add new ones for future growth.
How Does the Cost of Sales Affect the Price of Sales?
If you don’t have a handle on your cost of sales, it’s nearly impossible to price your products to make a profit. Likewise, pricing items too high causes demand to suffer, and sales may plummet.
Once you keep on top of the cost of sales, it’s easier to determine pricing.
For example, if it costs $30 to produce a product, a business owner may set pricing at $45 to $60 to recognize a profit. If he or she doesn’t know the exact costs to produce a profit, they’re merely guessing at pricing. The same business owner who prices an item for $45 and it costs $50 to produce quickly loses money, taking into consideration that fixed and variable costs remain constant.
Once you know all your direct and indirect costs are covered, you can be more competitive with pricing. Even so, history proves that customers will only pay so much, and pricing has to keep pace with what’s trending in the market.
To sum up, by regularly using a formula to determine the cost of sales, there’s a much higher chance your business will operate in the black. Did you know there are other ways to generate more profit?
How Do You Generate More Profits Without Raising the Sales Price?
So you don’t resort to adjusting the sales price upward, you can reduce your cost of sales, resulting in increased profits. You can do so the following ways:
- Don’t Just Focus on Revenue: Reviewing your cost of sales data provides a real-time snapshot of profit percentages. This significant number is one of the first indicators to reveal you may need to trim specific costs. A simple internal control like this can increase the bottom line.
- Rethink Labor Costs: Cross-train employees so they can handle more than one job. Should an employee need to take an unexpected leave of absence, there won’t be any downtime in production. Run a tighter ship by training existing employees to learn a new skill. You should experience less turnover when newly trained employees know a pay increase is on the way. You’ll save money in the long run when you don’t need to retrain new employees, which involves a learning curve, equating to less productivity.
- Shop Around for Less Expensive Raw Materials: The last thing you want to do is purchase inferior materials at a reduced price. However, it’s possible another reputable vendor may offer the same product at less cost. It never hurts to see what other suppliers charge and take advantage of the savings. Moreover, a new vendor may offer a discount for paying early or buying in bulk.
Once you make these simple recommended changes, there’s no need to raise your prices. If your prices seem too high to customers, they will start shopping elsewhere for a better deal. To keep that from happening, there are other actions you can take.
What Are Some Tips to Increase Sales and Profits?
By now, the term cost of sales may not seem nearly so daunting. In fact, there’s a good chance you’re all in and ready to implement strategies that will help your business grow. Here are a few more helpful tips
- Listen to Your Customers: Both positive and negative feedback is essential to help keep you on a steady course. Your customers want to know that the person in charge is available to resolve issues, listen to recommendations, or respond to glowing reviews about your business.
- Implement Lost Leader Pricing: To create a buzz about your quality products, you can attract customers by lowering pricing on one or more select items. No, this isn’t a bait-and-switch tactic where you substitute an inferior product in place of a superior one. You know going in that you may lose money, but there’s also the possibility that customers will buy additional products. See this article for more details on how lost leader pricing can increase sales.
- Spend Time Choosing the Right Sales Team: Finding the right people to sell your products can mean the difference between mediocre and a substantial increase in sales. In most situations, it’s not necessary to spend more money on additional employees but to provide training and incentives for your existing sales staff. A more diverse team increases your chance of reaching all types of people.
- Offer Discounts Strategically: If you offer seasonal discounts for a limited time, customers may take a closer look at your other products. Without going overboard, you can build discounts into your marketing plan throughout the year because customers love deals no matter when they’re offered!
- Market Your Products Differently: If sales seem to have stagnated, reach out to your existing customers and, in the process, find new ones. Nearly everyone these days has a social media account. You can use these platforms to reach people as well as other marketing tactics.
- Don’t Forget Growth Evaluation: Our free survey quiz provides the clearest picture of areas in your business that need attention. The straightforward form addresses the crux of what keeps businesses from experiencing sales growth. We can recommend immediate steps you can take to keep your business moving forward.
By tweaking your action plan, even a little, it’s possible to make immediate changes to realize an increased profit. Remember, Camino Financial specializes in helping business owners excel and thrive amidst a workaday world.
By now, you know the importance of knowing how to calculate your COS. And now that you have the tools to do it, success is closer than you imagine!
If you need a financial push in the form of a loan, we’re here to help. At Camino Financial, we live up to our motto, “No business left behind,” by helping all business owners that are looking for a financial partner. Get a quote today and start growing your business.
Remember, we’re only a click away and look forward to working with you soon!