This amount includes the cost of materials and labor directly used to create a product or service.
This excludes indirect expenses such as distribution costs and sales force costs.
What's more, the cost of sales is considered an important metric in the financial statements of every company, since it subtracts from the income to determine its gross profit.
The latter is a profitability measure that assesses the efficiency of a company in managing its labor and supplies in the production process.
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This type of amount is considered an expense in the income statements and helps analysts, investors and managers to estimate the bottom line of a company.
If cost of sales increases, net income will decrease. Although this move is beneficial for income tax, the company will have less profit for its shareholders.
Therefore, companies try to keep their cost of sales low so that net profits are higher.
The cost is acquired when the products that a company sells during a period, so the only costs included are those that are directly linked to the production of the products, including the cost of labor, materials and expenses. general manufacturing.
For example, the cost of sales s for an automaker includes the amounts of materials of parts used to manufacture the car, plus the value of labor used to build the car.
The cost of shipping the cars to dealerships and the cost of labor used to sell the car would be excluded.
In addition, the costs of cars that were not sold during the year will not be included in the cost of sales calculation, whether the amount is direct or indirect.
In other words, cost of sales includes the direct value of producing goods or services that were purchased by customers during the year.
What is the cost of sales formula?
The cost of sales formula can be calculated in two different ways: The cost of goods purchased or manufactured can be adjusted by the change in inventory during a given period.
Or you can add the cost of goods purchased or manufactured to inventory at the beginning of a period and subtract it from inventory of goods at the end of a period.
The main components that we need to calculate the cost of sales equation are: The starting inventory, the cost of direct materials, the cost of direct labor, the overhead, the ending inventory and the cost of acquisition or manufacturing of new products.
Let's look at an example: Company ABC is a manufacturer of heating systems. Maria, the company's accountant, is asked to calculate the cost of sales based on the company's transactions in August. Maria creates a breakdown of the transactions with the following information:
ABC Transaction Breakdown
- Raw material purchased € 62,000
- Cost of direct materials € 55,000
- Cost of indirect materials € 5,000
- Direct labor cost € 78,000
- Indirect labor cost € 10,000
- Initial inventory € 25,000
- Final inventory € 18,000
- Manufacturing cost of general expenses € 20,000
- Environmental and Social Management System € 21,500
- Initial inventory of finished products € 5,000
- Inventory of finished products € 11,000
First, Maria calculates the total manufacturing costs by adding the cost of direct materials: the cost of direct labor, the cost of manufacturing overhead, the cost of indirect materials, and the cost of indirect labor. .
The total manufacturing costs are 168,000 euros.
Second, Maria adds the beginning inventory and subtracts the ending inventory to calculate the cost of the manufactured goods, which is 175,000 euros.