Expert Advice Planning Small Business Info

A Blog about COGS: Understanding Your Cost of Goods Sold

Today’s topic deals with the Operational side of the business for all of you current and future entrepreneurs out there.

Typically, when we think of purchasing an existing business or opening our own business, our initial thought is how to grow sales. The next thought tends to center around who the current and/or potential customer is, and perhaps even where we may find more customers. But most times, the last thing we think about is the cost of goods sold which is more universally known as “COGS.”

CalculatorTip #1 – Know Your Numbers
When you are focused on your sales goal, remember to calculate in the “cost” of the goods for the sale. If you don’t keep a good pulse on your overall costs, you can quickly end up in the red after adding in other selling costs, which we will cover later in the blog. For every item that you sell, be sure that you have accurate cost of goods data to work from, as estimating can cost you big bucks.

“Cost of goods” is comprised of the following components:
– Direct materials
– Direct labor
– Factory overhead
– Freight in and freight out

Tip #2  Set a Realistic COGS Goal for the Business
Based on your business model, there are a variety of ways to set realistic cost of goods goals, but I am going to give you a few scenarios to think about.

If your business has to compete in a price-sensitive market where you have a lot of competition, you most likely will have to maintain lower profit margins to remain competitive. Having a good understanding of your COGS and how you can make adjustments is critical here. Your goal number is somewhere between 25% and 35% depending on your other expenses and order volumes.

If your business has less competition, and your market can support a higher retail price model, then you have a bit more wiggle room. Keep this thought in mind though — 1% either way can mean thousands of dollars depending on the size of your business.

Tip #3 – Look at COGS from Every Angle
Materials, volume, delivery time, your discount strategy, they can all affect COGS. Ask your suppliers for suggestions on different raw materials and/or finishing processes. You may find that there is a less expensive raw material that would be a transparent change to your current finished product.

Consider buying at higher volumes if your sales can support the additional costs ahead of the potential incoming sales. Or look at adjusting your delivery time to potentially decrease labor costs without negatively affecting the customer experience. Perhaps you should revise your current discount strategy to allow for more profit at the end of the sale.

Lastly, don’t forget to add in additional advertising, commission and operating expenses to get to the true cost of the sale. You may find that certain items won’t work in certain advertising channels as the “cost” of the sale exceeds the actual sale. Test different advertising channels to find the one that works best for your business.

I hope this information helps you be more aware of your COGS so that you can make smarter business decisions in the future.

What’s your game-changing plan to move your business to the next level? Please share your advice in the comments below, on our Facebook or Google+ walls or tweet us. Or, feel free to reach out to me directly with any questions or comments at [email protected].

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