SALES ANALYTICS
COGM - Cost of Goods Manufactured
It is not a secret that the process of making or producing goods comes with a price, albeit time, energy, labor, and capital. Because of this, companies must be extremely diligent and purposeful with how they invest their resources in order to bring a sell-able product to the market.
This is when calculating the costs of the manufactured good is a crucial task to improving sales and ensuring that they are using their resources efficiently. When done properly, it is a tool that allows a business to maximize profits.
What does Cost of Goods Manufactured mean?
Also known as COGM, the Cost of Goods Manufactured is a term often used in accounting principles.
But what does it mean? To put it simply, it talks about the total costs of manufacturing or producing a particular good in a specific period of time up until it gets transferred into the designated inventory for finished products.
In its essence, knowing the data in COGM allows the company to determine whether the expense of producing a particular good is more expensive than the profits they bring in, or low that it gives them more value to manufacture.
Why is calculating COGM important from a business standpoint?
““A fool and his money are soon invited to part company.””
Knowing exactly how much it costs to produce a good goes beyond doing stock inventory for a company. In fact, not learning about how to calculate COGM can easily break a business.
According to the Federal Reserve Bank of St Louis, manufacturing accounted for 11% of the overall US GDP in the 3rd quarter of 2020 (1). With just this resource alone, we can see that manufacturing plays a very large part of our domestic economy and that many businesses need to have a full grasp of this metric. COGM also helps you understand which cost in particular is making up a large percentage of your overall cost. In this case, you can work on reducing that individual cost to maximize profits.
Since COGM displays a company’s production costs, it helps the business get a clear picture of their costs throughout the production process. If you are an entrepreneur who is not doing this yet, use COGM now to avoid wasting any more of your time and resources.
What are the other benefits and uses of COGM?
Why do business owners have to make sure that they are utilizing the costs of the goods they manufactured? Here are some of the primary reasons why doing so would be advantageous to your company.
1. It helps a company manage their stocks
When a business makes use of the data in its COGM, it can be easier to keep and manage its inventory. Since inventory management is one of the most important aspects that a manufacturing company needs to do to keep track of their products, doing so will help ensure that they are maximizing their assets effectively.
2. It helps a company improve their strategies
Knowing the costs you need to manufacture a good will allow you to see which aspects of the production process are profitable and which need attention. In this case, business owners can thoroughly assess which areas are costing a lot to do and may find alternatives in order to gain more profit.
3. It helps a company to keep and analyze financial records
Calculating the COGM every month, quarter, and year will be an essential record to seeing that your company’s financial goals are being met. Since it is a critical metric to see and compare if manufacturing costs are higher or lower for any given time period, owners and analysts can put this data to work and improve their profitability.
4. It helps a company maximize their earnings
By now it should be evident that keeping a close eye on Cost of Goods Manufactured is a critical KPI for manufacturing companies to ensure profitability. Because it gives an idea of the surplus or deficit of the resources that are being used, owners can change their process, supplier, pricing, and other aspects to squeeze out more profits.
How do you calculate COGM?
Now that we understand what COGM means and the benefits it can give to companies, it is time to know the way to calculate it. We can do so with a simple formula, which is:
Cost of Goods Manufactured
Direct Material and Labor Cost + Manufacturing Overhead + Beginning WIP Inventory – Closing WIP Inventory
It might look confusing and involved, but I promise it’s relatively straight forward. Here are the individual components that are included in the formula and a simple explanation of what it is:
Defining the terms in the COGM Formula
a. What are Direct Material and Labor Costs?
Direct labor costs are the expenses that have to be paid to workers and staff to produce the goods. This includes the resources needed to pay for their regular working hours and also the overtime fees that they have put into their service. Direct materials are the supplies necessary to manufacture the product.
Aside from the wages, direct labor also includes the amount necessary for payroll taxes, employee contribution, insurance, and benefits. Many companies use their timesheet logs to see their actual expenses every period.
For example:
Here is the direct material and labor expense of ABC Widgets Inc.: last September 2021:
The wage of employees involved in the manufacturing process - $50,000
Direct material fees - $3,500
Total direct material and labor cost for September 2021 - $53,500
b. What is Manufacturing Overhead?
Manufacturing overhead costs are the expenses that are indirectly incurred in the production process. This usually includes the fees to pay for electricity, rent, property taxes, other utilities, the salary of indirect labor such as maintenance and quality control staff, insurance, and indirect materials such as maintenance supplies.
Here is the manufacturing overhead expense of ABC Widgets Inc.:
Utility fees - $5,000
Repair and maintenance fees - $4,000
Insurance fees for the equipment - $7,200
Indirect labor costs - $3,000
Indirect supply costs – $9,000
Total manufacturing overhead cost for September 2021 - $28,200
c. What is Beginning WIP Inventory?
Beginning work in progress inventory includes the expenses of the raw materials and goods that are still unfinished and is still waiting to be completed or sold during a particular period of time.
Here is the beginning WIP inventory expense of ABC Widgets Inc.:
Raw materials in stock - $3,200
Additional purchase of raw materials - $4,000
Total beginning WIP cost for 2021 - $7,200
d. What is Closing WIP Inventory?
Also known as ending work in progress (WIP) inventory, it is the goods that are in currently in the process inventory.
Here is the ending WIP inventory expense of ABC Widgets Inc.::
Cost of goods in the production process at the end of September- $10,000
Total ending WIP cost for 2021 - $10,000
e. What is the COGM of ABC Widgets Inc. last September 2021?
Using the formula and the expenses incurred by the company, we will know that:
Direct Materials Cost + Direct Labor Cost + Manufacturing Overhead + Beginning WIP Inventory – Closing WIP Inventory
Add the following:
Direct Material and Labor Cost - $53,500
Manufacturing Overhead - $28,200
Beginning WIP Inventory - $7,200
Total: $88,900
Subtract the Closing WIP Inventory - $10,000
Cost of Goods Manufactured (COGM) by ABC Company in 2021: $78,900
Conclusion
Without a doubt, knowing the Cost of Goods Manufactured (COGM) is an essential tool to improve your business profits.
Since it can effectively show the numbers and data that manufacturing companies need to see and assess if their current process is working profitably, it can serve as a guide to make adjustments and eventually maximize sales and your bottom line.
Increasing company revenue is our specialty, especially when it comes to generating more sales from your existing market. Tapping into your warm market is a logical place to start. We can extract already-existing company data to pinpoint where your next sale should come from and how much in sales volume. Schedule a meeting with a ReconInsight consultant and let us know about your sales goals.
References
Value added by industry: manufacturing as a percentage of GDP
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