Effect Of Financial Factors On Your Business
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This is probably the most important cost to be recorded in your account book. Cost of goods sold (COGS) simply refers to the direct costs that can be attributed to the production of the goods sold in a company. This amount includes the cost of the materials used in creating the good along with the direct labour costs used to produce the good. It excludes indirect expenses such as distribution costs and sales force costs. For example, the COGS for an automaker would include the material costs for the parts that go into making the car plus the labour costs used to put the car together. The cost of sending the cars to dealerships and the cost of the labour used to sell the car would be excluded. Furthermore, costs incurred on the cars that were not sold during the year will not be included when calculating COGS, whether the costs are direct or indirect. In other words, COGS includes the direct cost of producing goods or services that were purchased by customers during the year.
COGS has a great impact on your business as it can be directly related to the profitable pricing of your products. Compare your COGS to your pricing. If your price is lower than your COGS, it means that every time you sell something, you’re losing money. Let’s assume you have a price that is higher than your COGS. Whatever is left must cover all your overhead, general labour and deliver a profit. This is where the volume matters. If your product or service only leaves a pound after COGS, you need to sell like crazy to cover overhead and generate a profit. However, if your product or service has £10,000 after COGS, then a goal of selling 100 units is reasonable. Also, the calculation of COGS has a direct impact on your tax situation. Cost of Goods Sold is considered an expense, therefore the larger it is, the lower is your taxable income.This is something the IRS can and does audit to ensure your reported business income is not artificially low. Be sure to keep clear records, using a consistent process from year to year. There is another less obvious tax implication to Cost of Goods Sold. If your business carries inventory, the value of your inventory at year end is calculated using Cost of Goods Sold. However, always remember that your inventory may be taxable. Be sure to discuss this with a tax professional.
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