Understanding the true cost of producing your goods is key to being able to turn a profit. Most businesses make an attempt to calculate their cost of goods, but they may still find it difficult to earn a profit. One big reason is that they may not be accurately tracking the real cost of producing goods. If you are in the same boat, you may also be underestimating the cost of making items for sale.
How can you do better in order to boost your profit margins? Here are three key things to understand about COGS.
1. Decide on a COGS Calculation
The basic elements of a Cost of Goods Sold (COGS) calculation are the actual cost of what you buy and resell. Since raw and finished materials change prices all the time, how can you properly account for costs? There are a few methods of valuing your inventory. You might use either FIFO (first in, first out) or LIFO (last in, first out) pricing. The 'lower of cost or market' also helps account for pricing fluctuation.
Use one method consistently for the best results. If you're unsure how to best deploy inventory costing strategies, an experienced accountant can help.
2. Include Overhead Items
In addition to actual materials, some business managers fail to fully account for additional costs of production. This includes freight to get materials to your facility, paying labor or outsourcing any part of production, tools or equipment used directly in the process, and even fringe benefits to employees who work on the productions. If you don't include these overhead costs, you under-report what it takes to get items from raw materials to finished goods.
3. Include Your Labor
A small business owner is unlikely to value their time and energy properly. After all, you often don't have to pay yourself for your work. But not including the cost of producing your own work will undervalue what it takes to get goods in the hands of customers. You might value your time by estimating what you would pay others to do the same task. Or, you could count your time in terms of what tasks you are not doing because you're involved in production.
Either way, even if the amounts are not included in the books or taxes, you should include them in estimates of what you need in order to make a profit. It is the only way you can hand off any work and still create a viable business.
As you more accurately calculate the money and time it takes to produce inventory, you can more easily target ways to increase your profit. Not sure where to make improvements? Consult with a business accounting professional in your area today.