How to calculate your Cost of Goods Sold (COGS)

To calculate your Cost of Goods Sold (COGS) for a single item, you simply add up all the direct costs of acquiring it. This means the price you paid for the product plus any shipping or import fees you paid to get it to your business. Getting this figure right is crucial because it directly impacts your pricing, profit margins, and tax calculations.

What exactly is COGS?

Think of COGS as the cost of everything that is physically part of your finished product. It includes the direct costs of purchasing the items you plan to sell. It does not include indirect costs like your marketing budget, rent for your shop, your own salary, or the cost of shipping an item to your customer.

Key takeaway: COGS covers the costs to get the product, not the costs to run your business.

Why is calculating COGS so important?

It might seem like a bit of accounting jargon, but COGS is one of the most important figures for a business that sells physical products. Here’s why:

• Smart Pricing: If you don't know the true cost of a product, you can't price it effectively. Pricing without knowing your COGS is just guesswork, and you risk selling products at a loss.
• Understanding Profitability: Your gross profit is calculated by subtracting COGS from your revenue (Revenue - COGS = Gross Profit). This tells you how much money you're making from selling your products, before you account for your other business overheads.
• Accurate Financials: COGS is a key line item on your profit and loss statement and is essential for calculating your taxable income at the end of the year.

How to calculate COGS for a single product

For a new business, the simplest way to start is by calculating the COGS for each individual product you sell. Follow these steps:

1. Find the purchase price: Look at your invoice from your supplier or manufacturer. This is the base cost of the item.
2. Add any direct shipping costs: Did you have to pay for delivery to receive the goods? Add this on. If a single delivery charge covered multiple items, divide the total shipping cost by the number of items in that shipment to get a per-item cost.
3. Include other direct costs: If you had to pay any import duties or taxes to acquire the products, these should also be included.

The basic formula is:

Purchase Price + Inbound Shipping & Duties = Cost of Goods Sold (per item)

A quick example

Let's say you're opening a bookshop. You order 50 copies of a new paperback from a distributor.

• The trade price per book is £4.50.
• The distributor charges a flat £10.00 delivery fee for the entire order.

First, calculate the shipping cost per book: £10.00 / 50 books = £0.20 per book.

Now, add this to the purchase price: £4.50 + £0.20 = £4.70.

Your COGS for one copy of this paperback is £4.70. To make any profit, you must sell it for more than this price.

Keeping track

The best way to manage your COGS is to keep a simple spreadsheet. Create columns for the product name, supplier, purchase price, inbound shipping cost, and the final COGS per item. Every time you receive a new shipment, update your sheet.

Always keep your supplier invoices and receipts organised. They are the proof you need for your calculations and for when it's time to do your taxes. This simple habit will save you a huge amount of stress later on.