Demystifying COGS Calculation for E-Commerce: Understand COGS per SKU and Channel
Calculating the Cost of Goods Sold (COGS) is a fundamental aspect of running an e-commerce business. Accurate COGS calculation not only helps you understand your profit margins but also aids in making informed pricing and inventory management decisions. If you are a merchant selling through various channels like Amazon, Shopify, Walmart, and eBay, your COGS may vary per channel. Understanding the basic accounting principals behind COGS and the variables involved will help you increase your bottom line. In this guide, we'll break down the process of calculating COGS for your e-commerce venture, providing step-by-step instructions and insights to empower your financial management.
COGS represents the direct costs associated with producing or purchasing the products you sell. It includes expenses like raw materials, manufacturing costs, and shipping charges directly related to the production process. For e-commerce businesses, COGS typically includes:
- Product Costs: This includes the cost of materials, components, or finished products that you purchase from suppliers.
- Shipping Costs: Shipping expenses incurred to bring products to your warehouse or directly to customers.
- Direct Labor: Wages and benefits for employees involved in production, packaging, and fulfillment.
- Packaging Costs: Expenses for packaging materials and design, which contribute directly to the product's presentation and protection.
- Import and Export Costs: Fees associated with importing or exporting products, such as customs duties and tariffs.
- Platform Fees and Commission*: This category deserves an asterisk because depending on your business model, commissions can be included as part of administrative or operating expenses. However, commissions are commonly included in COGS because they are directly associated with the sale of an item. In e-commerce platforms charge a mandatory fee/commission for the sale of each good sold on their platform. For example, Amazon and eBay both charge a fee based on pre-determined percentage of the final sale price. It is generally recommended that e-commerce merchants include mandatory platform fees and commission in their COGS.
Your end of year accounting summary will give you the big picture of your overall profitability. You should consider the profit and loss for each product sold to help optimize your e-commerce strategy over time. Here is the big picture formula for calculating COGS:
- Beginning Inventory: Determine the value of your inventory at the start of the accounting period. This is the total cost of products you had on hand from the previous period.
- Purchases: Add up the costs of all inventory purchased during the accounting period, including product costs, shipping, and import/export expenses.
- Additional Costs: Include any direct labor or production costs associated with making or preparing the products for sale along with fees/commissions charged by e-commerce channels.
- Ending Inventory: Calculate the value of your remaining inventory at the end of the accounting period.
Now, use the following formula to calculate COGS:
COGS = Beginning Inventory + Purchases + Additional Costs - Ending Inventory
COGS Calculation Example
Let's say your beginning inventory value was $10,000, you made purchases totaling $25,000, incurred additional costs of $5,000, and your ending inventory is valued at $8,000. Applying the formula:
COGS = $10,000 + $25,000 + $5,000 - $8,000
COGS = $32,000
Understanding your COGS helps you determine your gross profit, which is the difference between total revenue and COGS. Gross profit is a key indicator of your business's profitability before considering operating expenses.
It's important to note that accurate COGS calculation requires diligent record-keeping and a clear distinction between direct and indirect costs. Regularly reviewing your COGS can also provide insights into your pricing strategy, supplier relationships, and inventory management practices.
While your COGS may be lower than your revenue, making you profitable overall, a closer look at your COGS per SKU and per channel may reveal some less profitable strategies that need correcting.
Calculate COGS per SKU
Calculating the Cost of Goods Sold (COGS) per SKU (Stock Keeping Unit) is crucial for understanding the profitability of individual products in your inventory. First off, you should gather the necessary information:
- Beginning Inventory Value: The total cost of the SKU at the start of the accounting period.
- Purchases: Total cost of additional SKUs purchased during the accounting period.
- Additional Costs: Any direct costs associated with the production, packaging, or import/export of the SKU plus fees/commissions charged by e-commerce channels.
- Ending Inventory Value: The total cost of the SKU remaining at the end of the accounting period.
Next, you should calculate the total COGS for the SKU: Total COGS = Beginning Inventory + Purchases + Additional Costs - Ending Inventory
Once you calculate the total COGS, you should count the number of units of the SKU sold during the accounting period. Then calculate the COGS per unit: COGS per Unit = Total COGS / Total Units Sold. To determine if the SKU is profitable, you should compare the total sales of that SKU to the COGS.
Regularly calculate and review COGS per SKU to ensure that your pricing and inventory decisions remain aligned with your business goals. This ongoing analysis can help you identify trends, make adjustments, and continuously improve your product offerings and profitability. You can also compare the COGS per channel to determine which channel offers the highest profits.
As a multi-channel e-commerce merchant, you're navigating a complex landscape encompassing platforms like Amazon, Shopify, Walmart, and eBay. Recognizing that your COGS may differ per channel is a critical step towards optimizing your strategies. Whether you're a seasoned entrepreneur or just beginning your journey, mastering COGS calculation can be the key to elevating your business to new heights.
Calculating the Cost of Goods Sold (COGS) is an essential skill for e-commerce entrepreneurs to master. By accurately determining your COGS, you gain valuable insights into your business's financial health, enabling you to make informed decisions that drive profitability and growth. Remember, diligent record-keeping and a thorough understanding of your direct costs are key to performing precise COGS calculations. With this knowledge in hand, you're better equipped to navigate the intricate financial landscape of e-commerce and position your business for success.