Calculating Cost of Goods Sold (COGS) is challenging for any eCommerce business. It’s not as simple as the cost per unit you pay your vendors. In addition to how you calculate that number, the bigger challenge is how do you automate it so you can scale?
Here are four areas to consider as you put together a solution to properly track COGS for your business.
What’s included in COGS, and what isn’t
The first area to think about is how to accurately calculate your inventory cost and, subsequently, COGS. It’s good to know what costs you incur should be included in your product cost (inventory on the balance sheet) which will ultimately hit COGS on your income statement as you sell it.
Getting this number right is critical in knowing your gross margin, a critical number important to any business. Many businesses fail because their margins are too low.
Cost of the product - the cost you pay your vendor for the products you sell.
Freight in - how much did it cost to get the product to your warehouse(s).
Duties and fees - any other costs incurred to get the product to you.
Freight out - costs you pay to ship the product to your customers.
Tooling fees - costs incurred for tooling.
R&D - costs incurred to research and develop the product before you are ready for sale.
Are you tracking manually or with a cloud-accounting system
The second area to consider is to determine which method of tracking inventory on hand and COGS should be used.
Method 1 – Manual tracking
This is a reasonable method if there are only a small number of products with costs that do not fluctuate. Inventory on hand can be easily counted periodically and the difference between the beginning and ending inventory cost is added to COGS.
This is not a scalable method and should not be used for a growing business.
Method 2 – Utilize a cloud-based inventory app
There are several cloud applications on the market and the best one for your company may depend on several factors. Below are the two most common systems that tend to work in most situations.
These applications do a little or can do a lot. The basic use case is to reconcile the sales channel deposits with your accounting system. That on its own is a very time consuming, frustrating process. More robust systems will actually track SKU level quantities, handle your POs, B2B sales invoices, and much more.
A2X - This simple tool is a powerful application that reconciles your settlement deposits.
Using Amazon Marketplace or Shopify
Product, freight in, and duty costs are stable
SKU list rarely changes
DEAR Systems - This application, and others like it, is what we’d call an inventory management system. As you start to scale in volume or number of sales channels, an application like this will be necessary.
Using almost any major marketplaces or shopping cart application
Product, freight in, and duty costs are variable
SKU list is growing
Purchase orders are used
Multiple warehouses exist
Manual sales may need to be processed
Manufacturing or kitting functionality is needed
Verify everything is flowing
The third consideration is to ensure that inventory balances and COGS are correctly recorded in your accounting system.
If manual tracking is used, then the entries into the accounting systems will also be manual. You may process when coding the bank activity and/or via a manual journal entry.
A2X and DEAR both integrate with the cloud-based accounting applications Xero and QuickBooks Online. These systems will automate some or all of the coding done in the accounting system.
The following are crucial to the successful launch of a cloud inventory app and integration with an accounting system.
Accurate beginning inventory count
Accurate beginning inventory cost
Inventory app configuration that matches your business processes
Solid integration configuration with your accounting system
Periodically verify inventory on hand
The last consideration is to ensure the actual inventory on hand (and related inventory value) continues to match between systems.
Integrated systems should keep quantity on hand current as you receive inventory or sell it. This is called a perpetual inventory system. Make sure you reconcile periodically to make sure the systems are staying in sync. Although applications automate a bulk of the work, exceptions can exist causing the system to fall out of sync.
If you are manually tracking your inventory, you will most likely be recording things periodically anyway. This will work for a smaller eCommerce business. As such, you may only need to track quantities in your sales channel and not need to worry about how it shows in the accounting system. Additionally, the lower volume will allow you to verify quantities on hand less frequently, quarterly at most to perhaps once a year.
Either way, when quantities don’t match what’s actually on hand, adjust they systems for any differences so they are back on track.
Make sure you continue to verify the flow is working as manual and automated processes can yield errors, either by manual data entry or broken integration between apps.
To achieve long term success as an eCommerce company, its imperative you calculate your inventory costs accordingly. it’s important to keep detailed records of all sales and expenses in order to calculate the COGS. If you need help, bring an expert in implementing systems and configuring them with a workflow that works for your team.