Understanding your cost of goods sold, often referred to as COGS, is an important piece of figuring out how to price your product. It’s also crucial to your ability to build a profitable, scalable business. What is included in Cost of Goods Sold, and how do you calculate it?
What is Included in Cost of Goods Sold
Cost of goods sold is the accumulated total of all costs used to create the product or service that you’ve sold to your customer. Because I work in the CPG (consumer packaged goods) industry, and because many startups begin with home recipes, I’ll use jam as an example.
Costs That Go Into Making Jam
In order to make and sell a jar of jam, you need to take into account:
- The cost of the ingredients that go into the jar (including shipping)
- The jar itself as well as the lid, the label, and any other packaging (including shipping)
- The labor, whether it’s yours or hired out to a contractor or a co-packer
|COGS for Jam
|Ingredients (berries, pectin, sugar, citric acid)
Why Include Shipping?
Most ingredient suppliers will charge you shipping to deliver those ingredients to the kitchen. You can’t make your product without the ingredients, so you include both the cost of ingredients themselves plus shipping. (Note: Ordering in larger quantities often means that you’ll get a price break on shipping and/or price per pound. But be careful! Start with small batches to ensure you have product-market fit.)
Why Include Labor?
That jam won’t make itself, will it? Whether it’s your own time, staff time that you pay for, or a co-packer’s fees, labor is an important part of the equation when it comes to making a product that you can sell to a customer.
What is Not Included in Cost of Goods Sold
- The cost of paying a graphic designer to mock up your label
- The cost of shipping your finished product to your customer
- The costs of marketing and promoting your product
These are just a few examples — but a good rule of thumb is that if it doesn’t go into the actually process of making the good that you sell, it doesn’t belong in your COGS.
Your COGS can and should change over time. Hopefully your COGS go down over time, as you’re able to buy ingredients and packaging materials in larger quantities and as you can produce in larger batches. But your COGS might go up, especially if ingredient prices go up or you decide you need to improve your packaging.
Once you understand how to calculate your COGS, you can begin to figure out at what price you need to sell your product in order to cover those COGS, the other costs of running your business, and also make a profit. We’ll cover that next week.