(Money Matters) Expenses: The real cost of business - Kasfia Rashid

Kasfia Rashid - "Money Matters with Kash the Bookkeeper"

​Introduction: 
Hello! Welcome to Money Matters with me, Kash the bookkeeper! Accounting is the language of business. If you own a business or you are thinking of starting a business, you need to know your numbers and how to use them! 

Money matters is all about the fundamental basics of the accounting language, Assets, Liabilities, Owner’s Equity, Revenue and Expenses. These building blocks of business can be arranged and rearranged for a customized experience. Once you understand the basics of any language it is much easier to communicate using that language. 

We are almost at the end of our accounting tour! Only a few more concepts remain, need to catch up? Click here for all of the prior shows:  https://feed.pod.co/money-matters-with-kash-the-bookkeeper

Last week we talked all about money, money, money… aka, revenue. This week we start our discussion on expenses. Expenses can be broken up into two main categories, “COGS” which stands for Cost of Goods Sold, and Operating expenses. Today we are going to take a magnifying glass to the concept of cost of goods sold. 

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​Show Objectives - The Why
What is the cost of conducting business? 

The answer will vary depending on who you ask. Some may say time, effort, and the dreaded FOMO (opportunity costs) are all “costs” of doing … well anything, but especially running a business. Ask a numbers person and chances are, their answer will have be something like this : “The Business Cost includes all the costs (fixed, variable, direct, indirect) incurred in carrying out the operations of the business. It is similar to the real or actual costs that include all the payments and contractual obligations along with the book cost of depreciation on both the plant and equipment.” 

In other words, it’s the money that is spent to provide a solution to clients (cost of goods sold), keep the business running (operating expenses), and allow the business owner to meet their desired level of success (owner’s distributions). 

The concept of cost of goods sold has its own section in accounting and financial statements. Cost of goods sold is the total amount of money it takes to provide a product/service for sale. In accounting this term is most often used in any product based industry, however, the concept can be used for both product and service based businesses.

Key Issues - Owner Perspective:

The cost of goods sold amount is usually the starting point of determining a price range for a product or service.  This amount can be calculated fairly accurately before starting the actual production of the product/sale. It can also vary greatly between industry or locality. Determining the cost of producing a product can help business owners choose which products to supply, where to supply them, and even how much to supply to ensure a constant stream of demand. At it’s core, it is a mini budget built around a business’s offerings. 
Once the cost of goods sold amount is determined, a small business can:

 1. adjust the price for maximum profit margin, 
2. find ways of lowering cost of goods sold, 
3. use that amount to justify loans and investments into the company. 

What You Need to Know - The What 

Calculating the initial Cost Of Goods Sold includes “direct material and direct labor” that go into making each item for sale. It does not include indirect expenses, like utilities, marketing expenses, or rent.  If you're in a product based industry this is usually quite simple. To find your cost of goods sold you add up the amount of money it takes to put a product together for sale, all of the various parts of the product, and the time it takes to put it together. 

The basic test you can use is, ask yourself : If I did not have _______ (fill in with cost in question) would I be able to provide my clients with a solution at the price I need?  

Ex : If I did not have a pen would I be able to provide my clients with a solution at the price I need? 
If answer is : 
Yes, then it is NOT a cost of goods sold. 
No, then it IS a cost of goods sold. 

The calculation of the total cost of goods sold plays an important role the value of a  business's inventory. If selling a physical product, “inventory” is what is sold. A business’ inventory might consist of items purchased from wholesalers or items made in house. Many businesses have a process of taking inventory a few times a year to ensure they have enough on hand for sales. 


​What You Need to Do​​ - The How

After determining the initial cost, a business now has to maintain the accounting side of tracking that cost across the months/years. In other words, a business has to start tracking inventory and changes to the inventory. 

*****Accounting equation alert! *****

Earlier this season we discussed a primary accounting equation A=L+OE ( check it out here) and COGS has provided us with our second accounting equation! 

COGS = Beginning Inventory + Purchases During the Period – Ending Inventory

Beginning inventory is the inventory left over from the previous period, this can be last year or yesterday! Then, add the total cost of what was purchased during the period. Subtract the inventory not sold ( but still available for sale) at the end of the period. COGS appears under a business’s sales, or revenue and is usually a negative number. Subtract the COGS from revenue to get gross profit margin.

Typically the cost of goods sold will change from period to period in every industry. COGS depends on changing costs and the inventory costing methods used.
The three inventory costing methods are:

• FIFO (first in, first out)
• LIFO (last in, first out)
• Average

If you use the FIFO method, the first goods sold are the ones which were purchased or manufactured first. Under the LIFO method, the latest goods purchased or manufactured are sold first. With the average method, you take an average of your inventory to determine your cost of goods sold. This keeps your COGS more level than the FIFO or LIFO methods.

Here are a few other things to keep in mind when setting up the Cost of Goods Sold section of your financial statements: 

1. Separate materials used to create product/service from materials used across all products/services. 
2. Include cost of labor, shipping, and packaging costs.
3. Track how much time it takes to complete each product/provide each service.
4. Don’t forget to include any bank/credit card charge fees associated with the sales.

The COGS section of the financial statements can make or break a company. It is where the smallest shifts can cause the largest impacts in a small business. By accurately calculating and predicting the COGS for a product or service, you gain full control over the final asking price and worth of that product. 

Additional Resources 

1. Check out Kash’s Youtube Playlist: Bookkeeping basics for small business owners. 
2. Source Articles https://www.thebalancesmb.com/how-to-calculate-cost-of-goods-sold-397501
3. https://www.patriotsoftware.com/blog/accounting/cost-of-goods-sold-cogs/
4. Want more KASH? Sign up for the free newsletter! 

Shows: 
Previous: Revenue: All that glitters is gold, right?
Next:  Expenses: Anchor or Submarine?

​Written by Kash the bookkeeper  
Check out the last QuickBooks Online Tutorial you will never need here! https://kashthebookkeeper.com/master-your-bookkeeping-in-60-minutes/

You can connect with Kash on any of her seriously social platforms under the handle @Kashthebookkeeper

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