12 December, 2023

Cost of Goods Sold (COGS) in a Perpetual Inventory System

Benefits of the Perpetual COGS Method and Using Connected Inventory Performance To Calculate It

If there’s one thing that product sellers have in common, it’s that driving passion that empowers them to launch their businesses. That said, it takes more than passion to scale a business into a lasting brand. Your drive and vision may have gotten your company off the ground, but you need access to the right data to transform it into a thriving brand.

Your cost of goods sold (COGS) is an essential metric for long-term growth and scale. After all, it doesn’t matter how much you sell if your prices can’t always cover the cost of inventory. When that happens, you either don’t have a reliable profit margin or are operating at a deficit. 

Product sellers who want to build a competitive brand need to understand the cost of goods sold (COGS) deeply, how it impacts their business, and how it can be used to create a strategic advantage.

What is cost of goods sold (COGS)?

Cost of goods sold is the direct expenses associated with acquiring, producing, and preparing the items you sell to customers. It includes expenses like inventory purchases, raw materials, freight, packaging, storage, and direct labor. That said, it doesn’t contain indirect costs such as your sales and marketing costs.

Understanding and monitoring your cost of goods sold is a key step in building a profitable business. When you know your COGS, you can use that information to improve your inventory control strategy, increase gross profit margins, and improve your business’s financial health.

Cost of goods sold (COGS) vs. cost of goods manufactured (COGM)

For manufacturers, cost of goods manufactured (COGM) represents the total costs involved in making products for sale, including works in progress (WIP) and the value of inventory that’s finished but hasn’t been sold. COGS, on the other hand, refers to the direct costs associated with the products that have been sold. COGS can only be calculated once the product has been sold. 

COGS and COGM include raw materials, labor, and factory overhead, and neither contains marketing or advertising expenses. The main difference between the two is that COGM is realized as costs occur, while COGS is only realized after a sale.

If you purchase your inventory instead of manufacturing it, you’ll use a metric called cost of goods purchased (COGP) instead of COGM. COGP includes the total cost of the inventory you buy to get it to your location and ready for sale, including costs like shipping. Similarly, once the items are sold, your COGP is realized as COGS.

Calculating COGS: Periodic vs. perpetual inventory methods

When calculating COGS, you can choose one of two accounting methods: periodic or perpetual. Periodic inventory calculates COGS after performing an inventory count. Perpetual, on the other hand, uses real-time data to calculate COGS after each sale.

Periodic method COGS

Traditionally, with a periodic system, businesses only calculate COGS after doing an inventory count, usually when preparing financial statements. After counting the amount of inventory, you can use the cost of goods sold formula for that accounting period:

COGS = Beginning Inventory + Purchased Inventory – Ending Inventory

Businesses often use monthly accounting periods, but the inventory counting process is labor-intensive and creates a delay in information. This method depends on a full stock count at the end of every accounting period.

In the periodic method, COGS is solely calculated for reporting and preparing financial documents, like the income statement at the end of an accounting period. Because business owners don’t have access to the information in real-time, they can’t use it for strategic planning during the period, such as reducing excess inventory for better cash flow.

Perpetual method COGS

Using new technology, modern sellers take a different approach to inventory and COGS calculations by using systems that cater to the use of the perpetual inventory method. In a perpetual system, costs are recorded during the inventory lifecycle, and the COGS for each item is recorded as soon as it’s sold.

For instance, if you sell witty socks, perpetual COGS tracks the per-unit cost of one pair of socks right up to the time you sell it. With new technology, such as a Connected Inventory Performance (CIP) solution from Cin7, your COGS for each item gets automatically recorded at the time of sale.

Benefits of perpetual COGS calculation

The main advantage of using a perpetual inventory system is tracking COGS in real-time, allowing you to analyze your costs on a product level, not just for reporting after the fact. It lets you calculate COGS without waiting for an end-of-accounting-period inventory count. 

Real-time access to COGS

An inventory platform that supports a perpetual inventory system lets you get faster access to information on the cost of goods sold because the information is perpetually updated. That way, you won’t have to wait to count inventory at the end of the accounting period.

With 85% of supply chain professionals planning to increase investment in their tech stack, it’s clear that technology-enabled operations are the new standard. For product sellers, finding an inventory management solution that provides real-time insights helps reduce production costs and operating expenses and increase net income

More accurate costing

Eliminating the need for physical inventory counts helps you reduce errors in manual counting, which can affect your COGS metric. Instead, the software keeps a live, accurate count of inventory levels, so you’re using better data for your cost calculations.

Improved decision-making

Faster access to your COGS means you can make more proactive data-driven decisions because you’re not waiting for a periodic inventory count to get cost insights. 

For example, if the cost of one of your products increases, you’ll have that information sooner and be able to identify the cost drivers, look for opportunities to reduce your expenses, or adjust your pricing accordingly.

Higher profitability

75% of business leaders say consistent use of analytics to make data-driven decisions leads to significant revenue gains. Access to real-time cost data empowers you to proactively manage your profit margins instead of waiting until the end of the year to review your performance and make changes.

Perpetual inventory method: How to calculate cost of goods sold without an ending inventory count

If you use the perpetual inventory method, you don’t need to do manual inventory counts at the end of a given period to get the ending inventory value. Instead, here’s how you find the cost of goods sold without ending inventory

Cin7 enables CIP and allows you to track your products through the entire inventory life cycle to ensure accurate costing. With Cin7, you can also adjust the software to fit your workflows and the costing method you use. Since you always have a live count of your inventory, you can automatically calculate the cost of goods sold without doing a physical count. 

With the help of software, you can calculate your COGS monthly, weekly, or even daily.  As the products move through the inventory lifecycle, associated costs are tallied, and then the cost is recorded once a product has sold based on your chosen inventory valuation method.

Costing methods for a perpetual inventory system

Inventory valuation is the process that you (or your software) use to calculate the value of the products you currently have on hand but haven’t sold yet. 

There are five popular inventory accounting valuation methods to choose from:

  • First In First Out (FIFO): COGS is calculated using the per unit cost of the oldest inventory items first. It assumes that the first products bought were the first sold. 
  • Last In First Out (LIFO): COGS is calculated using the per unit cost of the most recently purchased inventory. It assumes the most recently acquired inventory is sold first.
  • First Expired First Out (FEFO): COGS is calculated by using the per unit cost of the inventory with the shortest expiration date first. It assumes the products about to expire are sold before products with longer shelf lives.
  • Weighted Average: COGS is based on the average per unit price of your inventory items. The weighted average cost method is useful when you sell items that are difficult to distinguish from one another. 
  • Specific Identification: COGS is calculated based on tracking the specific cost for each unique unit of inventory. This can be done with RFID technology to track a single item through the inventory lifecycle. 

Cin7 supports the three most accurate methods: FIFO, FEFO, and specific identification. FIFO is the most commonly used and widely accepted as it provides accurate costing. FEFO is also widely accepted and often used by businesses with products that have expiration dates, such as medications or perishable food items. Specific identification allows pinpoint accuracy for companies with serial or batch number products that might otherwise rely on guesstimates for classes of products. 

How Cin7 enables perpetual inventory COGS tracking

By using Cin7 to calculate COGS on a perpetual basis, you don’t have to worry about manual inventory counts or waiting for the accounting period to end to get COGS. Instead, you can enable Connected Inventory Performance and get real-time visibility into your cost drivers and gross profit.

Cin7 facilitates customizable workflow management and automatically tracks inventory expenses, including materials, labor costs, and overhead, to provide accurate COGS data without the time-consuming manual calculations. Plus, live COGS data means you can adjust your profit margins on the fly by identifying high-cost items and reducing relevant inventory costs.

As a result, you can spend less time on inventory counts and manual calculations and more time making data-driven decisions that increase profitability and give you the resources to grow your business.

Cost of goods sold (COGS) in a perpetual inventory system

Modern sellers don’t need to wait for costly and time-consuming manual inventory counts at the end of accounting periods. By tracking inventory levels and COGS on a continual basis with CIP and Cin7 Core, you can respond effectively to changes in cost and adjust profit margins on the fly. 

Cin7 gives you full insight into your inventory from acquisition to sale and fulfillment, plus the ability to adjust for your workflow, so you know you have accurate real-time COGS calculations.

To see how it works, sign up for a free trial today.

Stop managing your inventory.
Start connecting it.