Do you know how to calculate your business’ Cost of Sales? Do you know what a Cost of Sales Formula is? Wikipedia gives the definition of Cost of Sales (CoS) as follows:
Cost of Sales, also known as Cost of Goods Sold (CoGS) is the carrying value of goods sold during a particular period.Wikipedia
Cost of Sales represents the direct costs related to the production or purchasing of goods that are then sold to a customer. In accounting, you then deduct this value from the turnover or sales figure to calculate the gross margin you generated.
The gross margin represents the “value add” of your business. This is the value you added to the raw materials, labour and overheads to produce a good or service.
The cost of sales in any business should include all of the costs you incurred in the production of your goods or the costs incurred to render your services.
The key elements which are generally included in the cost of sales line item are:
- Raw or direct materials and supplies used.
- Direct labour, including associated costs such as income taxes, UIF, SDL and employment benefits.
- Overheads of the business which can be directly allocated to production.
The first element of cost of sales is normally the direct materials you used in the manufacturing process. These raw materials are thus converted into the final product which you produce.
By way of example, we can use the old trusty bread example.
When you wish to bake a loaf of bread, you will need flour, yeast, salt and water as a minimum. All these ingredients are considered raw materials for the production of a loaf of bread.
The costs you incurred when you purchased these raw materials are included in your total costs of raw materials. Thus the value of raw materials will be the exact value you paid at the end of the day.
Direct labour costs consist of the wages and/or salaries you paid to the employees who are physically producing your products.
Thus, the total value you pay to all your employees who work in the factory and who work on the actual products must be included in this element.
The most important part here is that you include all the costs associated with these employees. This would include the actual wages and/or salaries paid into their bank accounts, the taxes you deducted, UIF contributions, SDL contributions, medical aid contributions, retirement contributions, training and the like.
Direct Overheads are those expenses you incurred to produce your products or services successfully.
The normal overheads incurred by a business can be divided into two categories. Those which can directly be attributed to the production of the goods or services and those which cannot.
Normally a business incurs some expenses which cannot be directly attributed to a product or service. These expenses can include your telephone and internet costs, business insurance and marketing costs. These are costs that the business must incur in order to produce its product, but the cost can’t be allocated to the production of the product.
Those expenses which you can attribute directly to the production of goods or services must be included in this element.
Expenses like the usage of water and electricity for the factory, safety equipment, repairs and maintenance of the factory and the like must be included in this line item. These are all direct overheads that can be attributed to the production of goods and services.
I hope this article helps you to identify and calculate the correct Cost of Sales Formula for your business.