Are your COGS controlling your business or are you controlling your COGS?

Your Cost of Goods Sold (COGS) are the direct costs associated with producing or acquiring your products or services, as well as cost of sales. This includes raw materials, labor, and manufacturing overhead. When your sales increase your COGS should increase as well, making it a good idea to look at your COGS as a percentage of revenue. 

Let’s look at an example, imagine a business with the following financials:

At first glance, the Cost of Goods is higher numerically, but when you examine the percentage, a different story emerges. In Month 1, the business spent 48 cents per dollar it earned in revenue. In Month 2, by controlling COGS, the business only spent 44 cents per dollar it earned. While 4 cents may not seem to be a huge difference, over the course of a year this can make a huge difference to the profit margin of a business. Too often, when looking at profitability business owners first look at fixed expenses, but controlling your COGS is just as important.

Why is COGS so important?

• Pricing Power: Knowing your COGS helps you set competitive and profitable prices. If your prices are too low, you risk eroding your profit margins.
• Identifying Cost-Saving Opportunities: By tracking COGS, you can pinpoint areas where you can reduce expenses. This might involve finding cheaper suppliers, streamlining production processes, or negotiating better deals with vendors.
• Boosting Profitability: Controlling COGS directly impacts your profitability. By reducing your costs, you increase your profit margins.

Let's break it down with an example: Imagine you own a bakery. Your COGS includes the cost of flour, sugar, butter, eggs, and labor. If you notice a 10% increase in the cost of flour, you can:

• Increase Prices: Raise the price of your bread to offset the increased cost. However, be mindful of customer sensitivity to price changes.
• Reduce Portions: Slightly decrease the size of your loaves without significantly impacting quality.
• Source a Cheaper Supplier: Research alternative flour suppliers who may offer lower prices without compromising quality.
• Improve Efficiency: Implement techniques to reduce flour waste during the baking process.

Tips for Effective COGS Management:

• Understand Your Costs: Break down your COGS into its individual components to gain a clear picture of your expenses.
• Track COGS Over Time: Monitor your COGS regularly to identify trends and potential issues.
• Benchmark Against Industry Standards: Compare your COGS to industry averages to assess your performance.
• Negotiate with Suppliers: Leverage your buying power to negotiate better deals and lower costs.
• Optimize Production Processes: Streamline your operations to reduce labor and material costs.
• Control Inventory: Avoid overstocking or understocking to minimize holding costs and spoilage.
• Reduce Waste: Implement strategies to minimize waste in your production process. 

By taking a proactive approach to understanding, tracking and controlling your COGS, you can improve your business's profitability and gain a competitive edge.