SCOR Metric CO.1.2: Cost of Goods Sold (COGS)

One of the most important metrics in this domain is Cost of Goods Sold (COGS), which provides a clear picture of the total expenses incurred to produce goods that a company sells. This blog post will explore the definition, calculation, data collection, and the importance of COGS in supply chain management.

What is Cost of Goods Sold (COGS)?

Cost of Goods Sold (COGS) refers to the direct costs attributable to the production of the goods sold by a company. This metric includes both direct costs, such as raw materials and labor directly involved in the production process, and indirect costs, such as overhead expenses related to production. Essentially, COGS represents the total cost of manufacturing a product and getting it ready for sale. It is a critical component in determining a company’s gross profit and overall profitability.

COGS is a key performance indicator for supply chain managers because it directly impacts the pricing strategy, profitability, and competitive positioning of a company. By understanding COGS, supply chain professionals can better manage costs, optimize resource allocation, and enhance overall operational efficiency.

Calculation of Cost of Goods Sold

The formula for calculating COGS is relatively straightforward. it is the cost to transform goods so that they can be sold.

COGS = COGS = direct material costs + direct labor costs + indirect costs related to making a product

Collecting and calculating COGS involves tracking various resource expenses, such as salaries, materials, and operational supplies, which are initially recorded in the organization’s general ledger accounting system. These expenses are then traced and assigned to the organization’s horizontal core processes based on factors like employee time and the number of units consumed. This data is typically collected from employee time-tracking systems and operational systems, such as Enterprise Resource Planning (ERP) systems.

Data Collection for COGS

Collecting accurate data for calculating COGS involves gathering transactional information related to resource expenses and operational drivers. The challenge lies in logically transforming these expenses into calculated costs based on cause-and-effect relationships, without resorting to arbitrary averages or factors. The main sources of data for COGS calculation include:

• General Ledger System: Captures all financial transactions, including expenses related to raw materials, labor, and overhead.
• Accounts Receivable and Accounts Payable Systems: Provide information on money owed to the company and money the company owes, which impacts working capital and cash flow.
• ERP Systems: Integrate various business processes, such as purchasing, production, and sales, and provide real-time data for cost calculation.

Accurate data collection and management are essential to ensure that COGS is correctly calculated, enabling better decision-making and financial planning.

The Importance of COGS in Supply Chain Management

COGS is a vital metric for several reasons:

1. Profitability Analysis: COGS is directly subtracted from revenue to calculate gross profit. A lower COGS indicates higher profitability, making it a critical measure of a company’s financial health.
2. Cost Control: Understanding COGS helps supply chain managers identify areas where costs can be reduced. This could involve negotiating better terms with suppliers, optimizing manufacturing processes, or reducing waste.
3. Pricing Strategy: COGS plays a significant role in setting product prices. By knowing the total cost of producing goods, companies can price their products competitively while ensuring a healthy profit margin.
4. Inventory Management: Analyzing COGS can help in inventory planning and management. Companies can adjust their inventory levels based on the cost of goods sold, ensuring they maintain optimal stock levels without overstocking or understocking.
5. Financial Reporting: COGS is a mandatory line item on income statements and is crucial for financial reporting and analysis. It provides stakeholders with insights into the company’s cost structure and operational efficiency.

Best Practices for Managing COGS

To effectively manage COGS, companies can adopt several best practices:

• Implementing Supply Chain Control Towers (BP.126): These provide end-to-end visibility and real-time data to help monitor and manage costs throughout the supply chain.
• Conducting Spend Analysis (BP.161): Regular analysis of spending patterns can help identify cost-saving opportunities and improve procurement strategies.
• Optimizing Inventory Levels (BP.028): By maintaining optimal inventory levels, companies can reduce holding costs and minimize waste, thereby lowering COGS.
• Leveraging Technology: Utilizing advanced technologies like ERP systems and automation tools can streamline processes and improve data accuracy for COGS calculation.

Conclusion

Cost of Goods Sold (COGS) is a critical metric in supply chain management that directly impacts a company’s profitability and financial performance. By accurately calculating and managing COGS, supply chain professionals can optimize costs, enhance operational efficiency, and drive business success. Adopting best practices and leveraging technology can further improve COGS management, providing a competitive edge in today’s dynamic market environment. Understanding and controlling COGS is not just about reducing expenses but also about creating a more agile, efficient, and profitable supply chain