The cost of sales is a number that manufacturers and other sales organizations use as a way to establish retail prices and calculate profit. You can calculate sales costs on a per unit or a per lot basis. Most companies decide which method to use based on how they buy their materials. In most cases, cost of sales does not include the cost of holding excess materials or the cost of products not sold. Those numbers are used for other calculations.
The Elements Of The Cost Of Sales
As with any calculation in the corporate world, you need to know the elements of the process in order to put the formula together. The elements of the cost of sales are materials costs, labor costs, overhead costs, indirect materials costs and indirect labor costs. Overhead includes all utilities, machines and machine maintenance costs associated with production.
Indirect material costs deal with packaging and marketing materials. Indirect labor costs include manufacturing maintenance personnel, management and and sub-contracted work.
Calculating Cost Of Sales
The formula for cost of sales is about as simple as it can get as all you do is add together all of the elements. The hard part is deciding if your calculation is per unit or per lot. You must determine which indicator you will use because that will dictate how you quantify your numbers.
For example, if you decide to use per unit calculations then you need to use a constant number for every element. If the direct labor costs used are for 10 units, then all of your other numbers must be gauged to apply to 10 units as well. If you are using random numbers without quantifying them, then your calculations will be incorrect.
This is the part of calculating cost of sales that most companies get wrong, and it is one of the most important aspects of their entire business. If the quantity numbers are not unified, then the profit numbers will be wrong and the company will never be able to track its revenue.
The best way for a company to get accurate cost of sales numbers is to bring in inventory experts who know how to adjust each formula element properly. There are many different types of cost calculating software available, but they all need correct numbers to work with. An inventory expert will know exactly how to get the right numbers and provide your company with costs you can rely on.
It is always best to buy materials in bulk and try to negotiate material costs that will remain constant throughout the year. Calculating the cost of sales and maintaining a good profit margin is much easier when the cost of materials remains the same.
When you manufacture products, you have to accurately calculate the cost of sales to be able to price your product competitively. If you know your profit margins are going to be slim, then it is critically important to develop accurate costs of sales with every inventory cycle.