Cost of Goods Sold - What does it cost to do what

What does your company do?  Some companies manufacture, some provide a service, others distribute.  The second line on a P&L is entitled Cost of Goods Sold (COGS).  It tells you how much money you spent doing whatever it is you do.  If you manufacture, it includes your labor and material costs and all other costs directly related to manufacturing.  If you are in the technology business COGS is a much smaller number.  In some businesses, COGS is a substantial cost and in others is a more modest expenditure.  In any business you want this number to be as small as possible and you want to reduce it over time if possible.

COGS tells you the costs that you incurred for the products or services that you sold for the period in question.  Even though you may have incurred other direct costs during the period, those costs are not reported as expenditures until the goods that were made or services provided are sold and paid for.  The costs of making products or providing services have to be matched up to the sale of that product or service in order to determine if you made a profit on those sales.  Otherwise, you would not know if you made a profit.  Your accounting system will put the right numbers in the right place in the right time period.  You can't be selling goods and services on which you do not make a profit.  You'll be out of business fast.  Businesses fail for a number of reasons.  In smaller enterprises and start up companies the biggest cause of failure is undercapitalization, a shortage of funds to run the business.  The second reason for failure is management error. A manager has to know if he is making a profit from one period to the next.

On a typical P&L statement the COGS line will be followed by several other line items representing a particular category of cost.  Each category of cost will have the total cost for that category listed to the right of the category name. Labor, inventory and overhead are typical categories listed.  There may be others depending upon how your accounting system is set up and the type of business you are in.  Discussing and investigating these categories of cost and the amount of money spent in each category, along with percentage changes, can lead to cost reductions.  

From a management point of view, you want to shrink COGS.  You want to reduce your costs or, at a minimum, maintain them.  Granted, costs will grow with sales growth but as a percentage of sales, you want to reduce, or at least maintain, the percentage where possible.  If costs are growing at a greater rate than sales you want to investigate this issue and correct it. 

You also want to initiate productivity gains where possible.  Productivity is huge and American businesses and workers are among the most productive in the world.  But to stay competitive in a global economy, as well as in the USA and local markets, you need to take advantage of every opportunity to become more productive.  Finding better ways of doing things is a daily challenge. 

Cost savings and productivity gains will help reduce COGS and ultimately improve your bottom line, your cash flow and contribute to accumulating more cash over time.