Here, you would get to know the easiest method to calculate the Cost of Goods Sold (COGS) for your Amazon FBA business. This article will cover the following points:
- Calculate COGS- Indirect Method
- Calculate COGS- Direct Method(easiest)
- Know how to interpret information
Calculate COGS for your Amazon FBA Business- Indirect Method
The indirect method to calculate COGS for your Amazon FBA buisness is to use the formula. The formula is
COGS, as it is evident by its name, is nothing but the cost of goods that your Amazon FBA business sold. When you deduct these costs from the number of sales made, you would get the amount of gross profit of your business. Calculating COGS is as simple as it sounds.
At the beginning of the month or year ( or any time for which you want to calculate gross profit) you had some inventory/goods. During the year or month, you purchased some more items for selling. Add it to your opening or beginning value of inventory. You get the total value of inventory available for sale.
Now at the end of the year, you go see some items are still there in your warehouse that haven’t been sold by your Amazon FBA business. This is your closing/ending inventory. Subtract the value of closing inventory from the total value of inventory available for sale. The answer is COGS.
You will get gross profit by the formula: Sales value-COGS = Gross Profit
This is the simplest way to calculate COGS. In case you have multiple products, you have the option to calculate gross profit for each product separately. But for simplicity, use the formula of COGS by adding costs of all products/goods.
The easiest way to do it is by using Excel. You can also calculate COGS through your accounting software if you are using any. Here is an example that worked out for you. This would further clarify the COGS concept.
Calculate cost or value of your inventory
It is indeed an important step. If you do not compute cost correctly, you might not price SKU( stock keeping unit) or goods rightly. The SKU price might be over or underpriced as compared to the optimum price( where you get maximum profit from selling in terms of selling price and number of units sold).
If the price is not optimum, the competitors may steal away some of your clients. In some cases, you might be making a good number of sales but still will not be getting the desired profits. The reason isreason, you have not calculated the cost of your SKU correctly.
This is why costing is a crucial step. Professional accountants know the significance of it. There are various ways, techniques, and methods to calculate the cost of the product or service. Some of the methods are absorption costing, variable costing, target costing, etc. These are complex and technical methods for non-accountant professionals.
But still, you do not need to worry. We will share with you the technique to calculate the costs as accurately as an accountant.
So here is how. First, remember that not every cost you incur in your business becomes part of your product cost. Your product cost is what goes into the calculation of COGS. This gives you gross profit. Deduct rest of the costs separately. So how to know which costs should become part of product costs?
Product Costs: Variable Costing method
The tip to know-how is simple. You must add all costs that have direct with your activity of purchasing. The more you, purchase the more it will occur. because you purchased that product. In other words, if you do not purchase that particular product, you will not encounter the costs associated with it. All those different costs that you incur due to purchase of the product become part of product cost. Such cost that arises due to the product is known as the product or service cost. Generally, these costs would include:
- Purchase price of the product/service
- Taxes paid or payable on the purchase
- Duties paid on the purchase of a product
- Freight and delivery charges if any
- Any other charges necessary to purchase the product
The above tip we talked about is known as variable costing or relevant costing. In other words, only those costs that you incur by purchasing a product should become part of it.
But this is not the only cost your business would incur. What about the payments that you have to pay anyway because you are in business. For instance, office building rent, utility charges, the fixed salary you might pay to your assistant, etc. These are also essential expenditures to run the business.
The benefit of using the variable costing method
So why should we not we make other costs part of our product as well? Is it not necessary that our product should cover all the expenses so that we make a profit?
This is a valid question. We need to cover all the expenses to make a profit. But if we mix these costs into product cost, it would blur our decision-making ability.
If product cost includes a fixed portion of the cost as well, it would lower the gross profit. It would seem like the product is not performing well. But in reality, this might not be the case. The product might be performing well. The non-product cost can be the reason for lowering your gross profits.
This is why managers often use variable costing methods . It bifurcates cost into variable and fixed components. The bifurcation separates the expenses related to a product from other charges. It would be irrational to include costs that are not caused by that product. In this way, you can see how well your product is performing.
The importance of the variable costing method becomes more significant when there are multiple products. In such cases, calculate COGS for each product separately. Once done, it would be possible to see how much gross profit each product generates. The comparison allows you to see which product needs more marketing, which needs better cost controlling, and which should be completely shut down.
During the start of the Amazon FBA business, there might be several one-time and other expenditures that would increase total expenses. For instance, purchase of digital instruments, digital advertising and marketing fee, insurance and coverage fees, etc. If you include these expenses within the product, it might give discouraging gross profit. Rather than that, you should divide these expenses throughout the period for which these fees are paid.
Calculating COGS- Direct Method (Easiest)
You can also calculate COGS in your Amazon FBA business directly without going into inventory levels. In this method, multiply the cost per unit by the number of units sold. You will get COGS. With this method, you do not have to account for opening and closing levels of inventory. All you need to know is the number of units sold. The steps involved are as follows:
Steps to Calculate COGS
- Calculate the cost per unit of your products or SKU( Stock Keeping Units). Be sure that you are using the variable costing method as discussed above.
- Calculate the total number of units sold in the period.
- Multiply these numbers of units sold with cost per unit of SKU
- The result would be COGS.
An Excel illustration- Calculate COGS
Let’s illustrate an Excel example here. This example would make it easier to understand the second method to calculate COGS. Suppose you have three products named SKU1, SKU2 and SKU3. Suppose per unit cost of each SKU is $15, $18 and $12. Numbers of each SKU sold in a month are 200, 150, and 35 each. COGS calculation would be as follows:
We calculated COGS separately for each product. This allows us to check the performance of each product or SKU.
Calculating COGS through the direct method is easier for so many reasons. Some of the reasons are:
- First, you don’t have to keep track of inventory levels all the time.
- Second, you don’t have to calculate ending level inventory.
- Third, whenever you make a sale, Excel can automatically calculate COGS for you.
- Fourth, you can update your cost at any time and your whole COGS and gross profit would be updated accordingly.
The above reasons make direct COGS methods very popular. It is especially easier for those who are from non-accountant backgrounds. They can easily calculate COGS through this method. All they need is to have some Excel skills. If you know Excel, you can set this formula and it will do all the job for you. You can automate your COGS and gross profit calculations.
Interpret information of COGS for your Amazon FBA Business.
You should interpret COGS with a reference point in your Amazon FBA Business. The reference point generally is sales. A good manager looks at COGS with respect to sales in regular intervals. This shows how much COGS is of sales.
Sales and COGS should move in tandem. If Sales increase, COGS should increase also. However, after t a certain point increase in sales might decrease a bit in COGS. For instance, Your supplier might give you a loyalty discount for establishing long term contracts , you might get bulk discounts for selling larger volume of SKU through your Amazon business, you might develop expertise to reduce lag time in fulfilling an order, etc. if a business manufactures a certain product for a long time, it might have developed expertise to reduce wastages, labor time and other expenses. This would translate that the business is developing and innovating as well. Thus, COGS show operational efficiency.
However, it is not necessary that this might happen. Although, a good business should develop methods to lower costs, yet some circumstances are out of its control. For instance, increase in duties, taxes, freight or other charges related to your Amazon FBA business might increase.in labor charges, product charges or other expenses, etc. In your Amazon FBA business, your Businesses cannot always increase prices with respect to expenses. If you does so, you might lose your clients to a competitor who is still selling the same product at a lower price. Therefore, in such cases, we would see that the Sales are not increasing at the same pace as COGS is. It would result in lowering of gross profits.