What is COGS? (and why it matters for your store)
COGS is the direct cost of making or buying what you sold, and working it out per item, as with a candle that costs Rs 120, shows whether your price really leaves profit.
COGS stands for cost of goods sold. It sounds like an accountant's phrase, but it is the answer to a plain question: how much did it cost me to produce the thing I just sold?
The meaning
COGS is the direct cost of the products you sold in a period. For something you make, it includes the materials and other items that go into each unit. For something you buy to resell, it is mainly what you paid the supplier, plus anything you spend to bring it to your shelf, like inward freight.
It does not include your general running costs, such as your phone bill, a marketing budget or your own time unless you choose to count it. Those are separate. How you treat COGS for accounts or tax is a question for your CA, so use this post to understand the idea, not as a tax guide.
A worked example: a candle
Say you make a candle. These costs are illustrative:
- Wax: Rs 55
- Wick and scent oil: Rs 15
- Glass jar: Rs 35
- Label: Rs 8
- Lid: Rs 7
Add them up: 55 plus 15 plus 35 plus 8 plus 7 equals Rs 120.
So your COGS for one candle is Rs 120. If you sell it for Rs 300, the gap is Rs 180. That Rs 180 is your gross profit on that candle, before you pay for packaging, shipping, payment fees, marketing and everything else. Whether you count packaging in COGS or separately is up to how you keep your books; just be consistent.
Why it matters
It sets a price floor. If you sold the candle at Rs 120 you would earn nothing, and anything below that loses money on every sale. Many sellers undercharge because they only count the jar and wax and forget the label, the wick or the wastage. Cost price of a handmade product worked example shows how to be thorough.
It shows your margin. The relationship between price and COGS tells you how much room you have for discounts and ads. See gross margin vs net margin for a small seller.
It shows when things change. If your supplier raises the price of wax, your COGS rises and your old price stops working. Supplier price rise and new selling price helps you respond.
Do not forget wastage
If you pour ten candles and two crack, your real cost per good candle is higher than the cost of the materials divided by ten. Count only what you actually sell, and include the spoiled ones in the cost. Raw material wastage in costing goes into this.
Batch costing
When you make a batch, add the full cost of the batch and divide by the good units. For example, if a batch of 20 candles costs Rs 2,400 in materials and 2 are unusable, then the cost per good candle is 2,400 divided by 18, which is about Rs 133. Compare that with the Rs 120 you assumed. Batch production cost per unit explains it.
Keep it simple
You do not need software. A sheet with one row per product and columns for each cost item is enough. Update the figures when prices change, and calculate again before you set a discount or run a sale. Then you will know what you can afford to give away.
Once your COGS is clear, pricing stops being a guess. Move on to price from target margin formula to see how to use it.