There are several ambivalent indicators by which business performance can be assessed. This means that it is beneficial for business owners that these indicators are low and high at the same time. This dual nature of these metrics can create a situation of uncertainty and, therefore, requires special impartiality on the part of businessmen. One such indicator is the Cost of Goods Sold (COGS).
The Importance of Cost of Goods Sold (COGS) Analysis
A company’s profit depends not only on the level of sales but also on how much money is spent on producing goods or providing services. The lower the cost of goods, the higher the company’s net profit. Therefore, reducing this indicator is one of the central tasks for each business.
If the COGS ratio is high, the company’s profit is negligible. And if the owners of the company took out a business loan to launch their project, they may find themselves unable to repay these debts. At the individual level, this problem is easier to solve, since a person can take cheap payday loans bad credit at Payday Depot. And when it comes to a company, a bad credit history can turn potential investors and partners away from it. Therefore, to keep your business viable, you need to carefully analyze this indicator and recipes for how to lower it.
How to Measure COGS
This indicator works only for analyzing the costs of production of the goods. It does not take into account indirect expenses, such as costs of marketing campaigns, distribution costs, etc. COGS includes only the following indicators:
- Manufacturing overhead
- Cost of labor
- Cost of raw materials, parts, etc.
The formula for calculating it is very simple: you need to take all the costs for these items and sum them up. You can also subtract COGS from sales revenue to find out the company’s profit.
Why Is the Cost of Goods Sold (COGS) an Ambivalent Indicator?
- On the one hand, companies with low COGS are attractive for investment. By optimizing labor and working with low-cost materials, you increase profits for shareholders. Therefore, companies with low COGS have a high chance of attracting investors.
- On the other hand, a high COGS is attractive for income tax purposes. When you claim COGS on income statements, it is subtracted from your total taxable income. That is why with a high COGS you can save on taxes.
How to Optimize Production and Lower COGS
If your cost of goods sold indicator is quite high and does not look good compared to competitors, you need to take some additional measures to optimize production:
- Consider alternative suppliers. Perhaps you are purchasing materials at too expensive prices. By finding a cheaper but still high-quality alternative, you will significantly lower your COGS.
- Perhaps you still have not automated routine processes. In this case, your labor cost will be higher than that of competitors who have switched to innovative technologies. Consider automating certain operations to free up some cash from production.
The cost of sold goods indicator is one of the most useful for assessing the financial health of a company. You need it not only to understand how well the company is doing. Investors evaluate you based on this indicator. So it’s in your best interest to keep it competitive.
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