How do I calculate COGS in my Amazon FBA business?
Here, you will 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 business is to use the formula. The formula is
As evident by its name, COGS is the cost of goods your Amazon FBA business sells. You will get your business’s gross profit when you deduct these costs from the sales made. Calculating COGS is as simple as it sounds.
At the beginning of the month or year ( or any time you want to calculate gross profit), you had some inventory/goods. During the year or month, you purchased some more items for sale. Add it to your opening or beginning value of inventory. You get the total value of merchandise available for purchase.
At the end of the year, you see some items in your warehouse that your Amazon FBA business hasn’t sold. This is your closing/ending inventory. Subtract the closing stock value from the entire list 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. If you have multiple products, you can calculate the gross profit for each product separately. But for simplicity, use the formula of COGS by adding the 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 the 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 compared to the optimum price( where you get maximum profit from selling in terms of selling price and number of units sold).
The competitors may steal some of your clients if the price is not optimum. Sometimes, you might make many sales but still will not get the desired profits. The reason 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 a 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 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 the rest of the expenses 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 directly with your activity of purchasing. The more you purchase, the more it will occur Because you bought that product. In other words, you will not encounter its associated costs if you do not believe that particular product. All those different costs you incur due to the product purchase become part of the product cost. Such a cost that arises due to the product is known as the product or service cost. Generally, these costs would include the following:
- 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 tasks necessary to purchase the product
The above tip we discussed is known as variable or relevant costing. In other words, only those costs 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 you must make anyway because you are in business? For instance, office building rent, utility charges, the fixed salary you might pay 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 make other costs part of our product? 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 costs, it would blur our decision-making ability.
If product cost includes a fixed portion of the price, it will 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 a variable and fixed components. The bifurcation separates the expenses related to a product from other charges. It would be irrational to include costs 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 requires better cost control, and which should be completely shut down.
During the start of the Amazon FBA business, several one-time and other expenditures might increase total expenses. For instance, the purchase of digital instruments, digital advertising and marketing fee, insurance, coverage fees, etc. If you include these expenses within the product, it might give discourage 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 directly in your Amazon FBA business without entering 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 by the 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 understanding the second method to calculate COGS easier. Suppose you have three products named SKU1, SKU2, and SKU3. Suppose the per unit cost of each SKU is $15, $18, and $12. Each SKU sold in a month is 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 always have to keep track of inventory levels.
- Second, you don’t have to calculate the ending-level inventory.
- Third, whenever you make a sale, Excel can automatically calculate COGS.
- Fourth, you can update your cost anytime, and your COGS and gross profit will be updated accordingly.
The above reasons make direct COGS methods very popular. It is significantly more accessible 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 to do the job for you. You can automate your COGS and gross profit calculations.
Interpret information on 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 concerning sales at regular intervals. This shows how much COGS is in sales.
Sales and COGS should move in tandem. If Sales increase, COGS should increase also. However, after t a specific point increase in sales might decrease a bit COGS. For instance, Your supplier might give you a loyalty discount for establishing long-term contracts; you might get bulk discounts for selling a larger volume of SKUs through your Amazon business; you might develop expertise to reduce lag time in fulfilling an order, etc., if a company manufactures a specific product for a long time, it might have developed expertise to reduce wastages, the labor time and other expenses. This would translate that the business is growing 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, some circumstances are out of control. For instance, increased duties, taxes, freight, or other charges related to your Amazon FBA business might increase labor charges, product charges, additional expenses, etc. In your Amazon FBA business, your Businesses cannot always increase prices concerning costs. If you do so, you might lose your clients to a competitor 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 a lowering of gross profits.