Calculating Cost of Goods Sold

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Published on
May 2, 2016

Pricing products can be tricky for even the most experienced and well-informed ecommerce store owners. How can you set your prices high enough so that your store is profitable, but competitive enough that your customers see value and keep purchasing from you?    

Various implicit factors - including competitor pricing, customer expectations, perceived value, and product demand - are all important considerations when it comes to pricing. But one explicit factor, your cost of goods sold - or COGS - is critical when it comes to setting your prices.    

Your cost of goods - or how much you paid to produce or acquire the products you're selling - represents a floor, and setting prices below that floor can have negative implications on your profitability. Sell items for lower than your cost of goods, and you're not making money.    

Here, we'll cover what cost of goods is, how to calculate cost of goods, why cost of goods is important and some examples and use cases for winning product pricing strategies.

What is cost of goods sold?

It's simple: your cost of goods sold, or COGS, is how much it costs you to produce or acquire the products you sell. Cost of goods sold include the direct material and labor expenses that go into the production of the items you sell. (Note: cost of goods doesn't include indirect expenses, like overhead, marketing or shipping costs, nor does it include cost for items you don't sell).    

When an ecommerce store purchases inventory from a third party, their cost of goods sold is equal to the expense associated with obtaining that inventory. When a store manufactures their own inventory, on the other hand, their cost of goods refers to the expenses directly associated with producing the products, like the cost of raw materials and labor.    

Here's a quick list of what's commonly included - and not included - in cost of goods for a clothing manufacturer and retailer:  

Included: Fabric, labels. buttons, thread, machinery and equipment, labor for design and manufacturing  

Not included: Marketing costs, overhead costs, indirect labor costs (i.e., for employees not directly involved with the production of your clothes)

Understanding Cost of Goods Sold

How to calculate cost of goods sold

If you use an analytics platform like Glew, it's easy to calculate your cost of goods sold automatically. We pull product cost data automatically from your ecommerce platform (or you can manually input or upload the values), and we'll calculate cost of goods sold for each of your products and across your whole store.    

If you're calculating cost of goods sold manually, you'll use this formula:  

Cost of Goods Sold = Starting Inventory + Purchases Made During Period - Ending Inventory

calculation for cost of goods formula

Your starting inventory is the total value (cost) of the inventory remaining from the previous period. Then, you'll add in the cost of products you purchased or manufactured during the reporting period you're looking at. Lastly, you'll subtract the value of the inventory you have leftover at the end of that same period.    

To get to those values, remember to take into account what goes into your product costs: only the direct expenses associated with obtaining your inventory.  

Here's an example:  

Consider the same clothing retailer as before - they're calculating their cost of goods sold for the previous quarter. Their starting inventory at the beginning of the quarter was $20,000. Over the course of the quarter, they manufactured $15,000 in additional inventory. They ended the period with $16,500 in inventory.  

Cost of Goods Sold = $20,000 + $15,000 - $16,500

Cost of Goods Sold = $18,500

exmaple for cost of goods calculation

The most basic use for cost of goods sold? Using it to calculate your gross profit, since gross profit is calculated by subtracting cost of goods sold from revenue.    In the example above, if the clothing retailer made $45,000 in revenue in the same quarter:  

Gross Profit = Revenue - Cost of Goods Sold

Gross Profit = $45,000 - $18,500

Gross Profit = $26,500

gross profit example using cost of goods calculation

In this example, you can easily see how cost of goods sold affects a business's profitability. If the retailer had had higher inventory expenses (in the form of additional inventory purchased or less inventory sold) that quarter, it would have cut into their gross profit significantly.

Why it's important to calculate cost of goods sold

Despite the importance of cost of goods sold for ecommerce stores, many store owners lack visibility needed to make comprehensive decisions using COGS. For instance, Shopify and WooCommerce do not offer robust cost of goods sold data, while Magento’s out-of-the-box reporting product does not immediately make COGS available.  

Accurate COGS data helps businesses price their products strategically and understand their top-line profitability - you need to know how much you spend on the products you sell to understand what to price them at, as well as how much money you're actually bringing in. Understanding cost of goods sold also helps stores strategize how to best market products based on profit margin (another way to think about profitability on an individual product level - margin is the percentage of profit made from the sale of each product).  For example, a t-shirt with a 15% margin could be a good candidate for a scalable email marketing campaign, while a higher-end bag or dress with a 70% margin could be a good candidate for more expensive forms of marketing like paid search or social media ads.    

In addition to marketing strategy considerations, stores can use cost of goods sold to price products more efficiently, so that margin is available to pay for operating expenses related to maintaining and scaling their business. Examples of these operating expenses include web hosting fees, development expenses, or the cost of maintaining an office space.

Product Pricing Strategies

Understanding cost of goods sold and profit margins are integral for product pricing for any merchant - but the specific pricing strategy that's right for your business may vary depending on your industry and products. Consider these pricing strategies that take into account your product cost, return on investment, competitor pricing and more.

1. Cost-plus pricing

Cost-plus, also known as keystone pricing, uses an easy rule of thumb that involves doubling the wholesale price or COGS for each product to determine its pricing

2. Target Return Pricing

This strategy involves determining a price that yields a set rate of return on investment for your inventory. So, based on a certain number of items you expect to sell, the target return pricing model computes the optimal price based on a projected total profit.

3. Competitive Pricing

Following the competitive pricing method, store owners set prices for their products based on what competitors are charging for similar products. This strategy may narrow the gap between cost and profit, but can help increase brand loyalty and lifetime value in especially competitive markets.

4. Value-Based Pricing

This pricing model takes into account a deep understanding of the value your products provide to your customers. It establishes prices largely based on perceived value by the customer, or how much the majority of your customers are willing to pay for your products.

Consistently tracking COGS may not be the most exciting task for online retailers, but doing it right is a critical factor in building a profitable and sustainable business that scales. Ecommerce stores that can master this metric will find it easier to calculate margins, determine ad spend and make future product and marketing decisions.

How Glew Helps Calculate Cost of Goods

It can be hard to calculate cost of goods sold - but Glew does a lot of the heavy lifting for store owners when it comes to incorporating COGS into the decision-making process. Using our Cost of Goods Sold tool, ecommerce stores can easily see their COGS, analyze accurate gross margins, net profit and sales margins for individual products and across their entire store.    

Our tool allows users to connect to COGS data in their ecommerce platform or import COGS data in bulk using a CSV template, and provides the ability to modify COGS data for individual products for the most accurate starting point.    

Integrated cost of goods sold data in Glew helps ecommerce stores understand their true profitability, optimize marketing strategy and advertising spend relative to product profitability and move away from a more generalized approach to product marketing.

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