Your margins look healthy right up until you find out your cost of goods sold was never calculated correctly. Stacy Walker breaks down four ways ecommerce sellers can calculate COGS: expensing inventory the moment you buy it, estimating it as a percentage of revenue, working from beginning and ending inventory counts, and tying unit cost directly to units sold. You get the tradeoff behind each one and why sticking with your choice matters as much as the choice itself.
Inventory & COGS
4 Methods to Calculate Cost of Goods Sold for Ecommerce Sellers
4 min
Transcript
0:00 Why COGS accuracy matters
Hi online sellers. Are you struggling to know your profit margins and how to accurately price your products? This might be because your cost of goods sold isn't being calculated correctly. Hi, I'm Stacy with LedgerGurus. If you're ready to get your finances in shape and boost your ecommerce profitability, then this video is for you.
Cost of goods sold, or COGS, is critical to financial management for an ecommerce business. It shows the direct cost of producing what you sell. It's not just a line item on your financial statement. It's the key to calculating your gross profit margin and assessing how efficient your business is running today. I'll go over the best ways to calculate COGS and the benefits for each method.
As a side note, we have an awesome video that explains the difference between cost of goods sold and cost of sales, which you might find helpful. They are not the same thing, and you don't want to get them confused. You can access that video through the link in the description. Okay, let's dive in.
0:55 Cash based method
First step is the cash-based method. With this approach, you expense all of your inventory purchases at the time that you buy them, so they immediately flow to the profit and loss statement. This method is best for small businesses using cash based accounting. It's simple and straightforward and ideal for ecommerce businesses who are just starting out.
1:17 Percentage of revenue method
The second method is percentage of revenue. With this method, COGS is calculated as a percentage of total revenue based on historical data. Let me give you a quick example. If you are selling dog leashes and you know that historically your business spends 60% of revenue on the total landed product costs, then you would take 60% of revenue and mark it as COGS for that specific time period. This method provides a quick way to estimate COGS without a lot of breakdown of product costs.
1:46 End count method
The third method is called the end count method. Here's how it works. You calculate COGS by subtracting your ending inventory from your beginning inventory while also considering any purchases you've made throughout the month. The formula looks like this: beginning inventory plus purchases minus ending inventory equals COGS for the given period. This method works great if you're frequently counting your inventory and using those numbers to calculate COGS.
2:19 Sales based COGS method
The last method is my favorite and what I consider to be the most accurate. It's called the sales-based COGS approach. With this approach, COGS is directly linked to your sales, so you'll take your unit costs, times that by the number of sales you've had, and that becomes your COGS for the given period. This approach gives you a detailed view of your cost of goods sold in relation to your sales throughout the time period.
2:45 Choosing a method and sticking with it
Each of these methods give you a unique insight into your ecommerce businesses' costs and financial performance. Which one you choose depends on the detail you want and the data you have available. Whichever method you choose, it's important to stick to it consistently, to keep your financials accurate and to provide you with comparable data over time.
If you would like help calculating cost of goods sold, LedgerGurus has a whole team that can help you do that. Reach out to us through the link in the description below. If you found this video helpful, like it, share it and subscribe to our channel for more ecommerce accounting tips.