Check out this simple guide explaining how any manager or business owner can easily calculate the costs of goods sold for an e-commerce business.
Digitalization and technological advancement have given us tremendous powers. Nowadays, everything is at the fingertips of the user. Whether it is buying groceries or booking a doctor’s appointment. You can do everything online and avail the benefits of the services at your doorstep.
Not only the users and customers but even the manufacturers and businesses have also been readily using these services to earn and grow. We see more and more businesses are creating an online presence by the day, allowing them to break the shackles of geography and reach customers in various areas, cities, states, and even countries.
There is no such thing that can not be ordered online and delivered to the doorstep and all this has become possible because of the e-commerce website.
Whenever it comes to converting a business to an e-commerce solution or getting a fresh start of the same, the most common question that appears is how to calculate the costs of goods sold for an e-commerce business. The query is quite straight however its solution; not so much. Different businessmen, subject matter experts, and intellects offer different solutions for this query. This, at times, makes things even worse.
That’s why we have brought forward this guide for you. Here we will understand how to calculate the COGS for an e-commerce business as well as get a deeper insight into various attributes related to this matter. So, without any further ado, let’s begin by understanding the definition of COGS. Also, if you want to save your time, then you can take benefit from our ECommerce Accounting Services.
What is the Cost of Goods Sold?
The direct expense that retail organizations, especially those that operate online, incur to sell commodities is known as the Cost of Goods Sold (COGS). Different aspects like manufacturing costs, direct labor costs, vending costs, price of raw materials, as well as supplier charges are all included in this. Additionally, it covers the freight charges, customs tariffs, and other fees necessary to get the commodity to your inventory or warehouse.
What’s the Importance of the Cost of Goods Sold for Any Business?
As you may have ascertained from the above definition, COGS defines the total money spent by any business to bring a commodity to the warehouse. For any business, what plays a major role in determining the levels of profit is the cost of the commodity(s) for the business. If you are unable to calculate the costs of goods sold for an e-commerce business or any other business for that matter, you may necessarily fail to make profits and lose your customer base.
The calculation of cost allows you to ascertain the levels of profit you can earn by offering goods at such a price that’s beneficial to the customer as well as the business. Apart from this, the COGS also helps the ‘produce and provide’ unit in understanding the KPIs or key performing areas. The business can also compare the cost with different periods to ascertain the change in profitability and its trend.
And this is not all, the accuracy of COGS also has tax benefits. You can easily show the authorities how the cost is derived for your business as well as the level of profits earned afterward. This helps businesses to be on the safer side with the regulatory authorities.
The definition of COGS and its importance must be clear by now. Let’s proceed toward the methods to calculate the costs of goods sold for an e-commerce business.
What are the Methods to calculate the COGS for an e-commerce Website or Business?
There is no rule of thumb that can help you calculate the cost of goods sold for an e-commerce business. The method to ascertain the cost depends upon the type of business, your cost dynamics, the type of costs involved, and more. However, generally, a simplified formula is used to ascertain the COGS. This is-
COGS= Initiating Inventory + Purchases – Closing Inventory.
This formula works normally but fails to include different aspects related to the cost like freight, delivery, transportation, and more. Hence, to provide accuracy in the calculation of cost, four techniques of calculation were derived. These are-
- Weighted Average Method (WA)
- Specific Identification Method (SI)
- First In First Out Method (FIFO)
- Last In First Out Method (LIFO)
Let’s understand the dynamics of these methods in detail.
1. Weighted Average Method (WA)
First, is the Weighted Average Method (WA) to calculate the costs of goods sold for an e-commerce business. Under this method, the aggregate cost of goods is calculated by considering the average weight of the price of different commodities. For example-
Let there be three types of commodities for a business costing at-
50 units @ $10 each,
100 units @ $15 each, and
150 units @ $20 each.
So according to the Weighted Average Method, the cost of goods sold will be:
Total cost/total units of goods= [(50*10)+(100*15)+(150*20)] / 300
= [500+1500+3000] / 300
=  / 300
Total = $16.66 per unit
This method is the best to calculate the cost of goods sold for an e-commerce business if the production is at a massive scale. Additionally, this method also makes it easy to ascertain the cost quickly.
2. Specific Identification Method (SI)
Second is the Specific Identification Method (SI). With the help of this method, you can calculate the COGS for an e-commerce website according to the cost of different products. For example-
Consider, the price of commodity A is $5 and that of commodity B is $10. If commodity A is sold, the COGS is $5, and similarly for that of commodity B is $10.
This method is best suited in situations where it’s necessary to differentiate the products.
3. First In First Out Method (FIFO)
The third method to calculate the cost of goods sold for an e-commerce business is the First In First Out Method (FIFO). Under this method, the COGS is calculated according to the cost of the first goods that come in and the first goods that go out. For example-
Consider, the price of commodity A is $5 and that of commodity B is $10. You purchased 1,000 units of A and 2,000 units of B but sold 1,500 units in total.
Originally the COGS is $25,000 (5*1000 + 10*2000) but according to FIFO, the COGS for 1,500 units would be 1000*5+500*10= $10,000.
With the help of this method, you can easily calculate the COGS if the goods involved are similar to that in the WA method.
4. Last-In, First-Out (LIFO) Method
At last, we have the Last-In, First-Out (LIFO) method to calculate the costs of goods sold for an e-commerce business. This method is the opposite of the FIFO method. Under this, the COGS is calculated according to the cost of the last goods that come in and the first goods that go out. For example-
Consider, the price of commodity A is $5 and that of commodity B is $10. You purchased 2,000 units of A and 1,000 units of B but sold 1,500 units in total.
Originally the COGS is $20,000 (5*2000 + 10*000) but according to LIFO, the COGS for 1,500 units would be 1000*10+500*5= $12,500.
Generally, the cost of goods rises as time passes. Hence, it’s better to use the LIFO method to calculate the COGS for an e-commerce website. As it allows you to show more cost and in turn helps you save tons of taxes in the longer run.
These methods are quite easy and allow you to ascertain the COGS very quickly. However, before proceeding with the calculation, you must know about the inclusions and exclusions of the COGS. Let’s know more about the same below.
COGS: The Inclusions and Exclusions
Accuracy of calculating the cost is the key to the growth of any business. Hence, experts recommend that businesses should always be aware of the things to be included in the COGS as well as things to be excluded. This helps the business with an accurate and viable calculation of the COGS without missing any important factor.
What Should be Included While Calculating COGS?
You should try to include the following aspects when trying to calculate the costs of goods sold for an e-commerce business:
- The actual cost of the product as charged by the vendor. Or the cost of converting raw material to final goods including the production costs involved in the process.
- The total freight in or the cost incurred while bringing the final goods to the inventory or warehouse.
- The cost of fees, bills, charges, and duties incurred while bringing the final product to you.
- Cost of advertising the business or its related attributes.
What Should be Excluded While Calculating COGS?
You should try to exclude the following aspects when trying to calculate the costs of goods sold for an e-commerce business:
- The total freight out or the cost incurred while bringing the final goods to the customer. (Including delivery and shipment charges).
- Cost incurred by any business for the tooling of the goods.
- Cost incurred by any business while conducting the research and development exercises for the benefit of the goods and the business.
Calculate the Costs of Goods Sold for an e-Commerce Business: Conclusion
When it comes to the effectiveness of the calculation of the COGS, accuracy is the key. If the data is accurate, any business can easily calculate the costs of goods sold for an e-commerce business as well as allow the business to grow quickly and stably. Doing this also means that the business can easily figure out the most impactful areas that increase the cost as well as work to eliminate these if possible. For accurate results get free consultation.