Buy $100,000 of inventory in January, expense it all at once, and January shows a loss while February and March look spectacular. That works until you are running multiple suppliers, varying freight, and returns. Kelley Birrell explains why growth does not break your COGS, it exposes the method you were already using, and walks the accrual approach: inventory sits on the balance sheet as an asset and moves into COGS as it sells.
Profitability
Revenue Growing but Profit Shrinking? Here's Why
5 min
Transcript
0:00 Why growth exposes COGS problems
You're hitting your revenue goals. Orders are up and sales are climbing. But somehow you're making less money than you did six months ago. Today, I'm going to show you why growth exposes COGS problems that you didn't even know you had, and what you can do about it.
Picture this. You're a seven figure Shopify seller. Things are going really well. You hit your first million doing inventory the quick way, buying product, expensing it immediately, and keeping things really simple. But then you double your revenue and suddenly nothing makes sense anymore. Your profit margins look wildly different from one month to the next. Your accountant is asking you questions that you can't answer, and you're wondering where all the money went.
So here's the problem, the real problem. Growth didn't break your COGS. Growth just exposed the problems that you already had.
0:49 The cash approach and what it does to your P&L
So the main problem is the cash approach, or what we sometimes call the default rookie error.
Let me show you what most sellers do when they start out. You buy $100,000 in inventory in January. You expense it all immediately. Your P&L that month shows a massive loss, even though you just stocked up for the quarter. Then February and March look amazing because you're selling through that inventory with zero costs showing up.
Your financials are swinging wildly. One month looks terrible and the next looks great. And when your business is small, you can sort of feel your way through this. You know what's in the warehouse. You remember what you paid for things. And you can keep it in a spreadsheet relatively easily.
1:30 What breaks when you scale
But here's what happens when you grow. You're ordering from multiple suppliers. You have SKUs with different costs. You're running promotions. You're managing returns. You're dealing with freight costs that vary by shipment. And suddenly, that simple method stops working. The spreadsheet isn't keeping up anymore, and your gut feel isn't enough.
Growth didn't create these problems. The problems were always there. Growth just made them impossible to ignore.
1:54 How it should work instead
So here's what should happen instead. When you buy that $100,000 inventory, it goes on your balance sheet as an asset. It's not an expense yet because you haven't sold it. Then as you sell products, the cost moves from inventory assets into cost of goods sold.
Now, let's assume that you have a 33% gross profit margin. If you do $100,000 in sales, that means that you sold $66,000 worth of product. That is your COGS.
So month one, you do $30,000 in sales. That means you sold $20,000 in COGS. Month two, you do $15,000 in sales. That's another $10,000 in COGS. Month three, you do $24,000 in sales. That's another $16,000 in COGS.
Now your margins are consistent, and you can see exactly how your business is performing, and you can make real decisions.
2:37 A $2 million cleanup
So here's an example. We had a client who was doing $2 million a year using the cash approach. They thought they were profitable, but some months showed 80% margins and others showed negative margins. Nothing made sense.
So we went in and cleaned it up and implemented the right COGS method for them. And turns out they weren't as profitable as they thought, but now they actually knew what was happening. They could fix pricing, negotiate better with suppliers, and grow strategically. That clarity is everything.
3:06 Why it's worth fixing now
So here's what you need to know. Small businesses can probably do the cash approach and get away with messy COGS for a while, but growth makes the cost of poor visibility much greater. Truly fixing your COGS is going to require a commitment to financial and operational maturity. But because it's your largest cost, visibility here will make a huge difference in your business and is worth the effort.
The important thing is this, fix it now before growth forces your hand.
Because here's the thing, when you get the COGS right, everything changes. You can finally see which products are actually profitable. You can make smart decisions about what to reorder and what to drop. You can price with confidence instead of guessing. You stop having those confusing months where your numbers don't match reality. And most importantly, you can grow without feeling like you're flying blind. That's what proper COGS tracking gives you.
4:02 Tools and next steps
Now, if you're managing inventory in Excel and you need some help, we've created a free inventory and COGS template that will help you set up a product cost catalog and track quantity and values. It will also help you compute COGS accurately. The link is in the description.
Now, for multi-channel sellers, spreadsheets are usually not robust enough to handle that amount of craziness. You'll need something more automated. When you're ready for an inventory management system, we can help you choose the right one for your business so your IMS and your accounting software actually talk to each other. The link to connect with us is also below.
Thanks for watching. Hit the subscribe button, drop a comment if this helped, and I'll see you in the next one.