E-commerce accounting: What is COGS and how do you manage it?
Laura Tien
November 20, 2023
E-commerce businesses will typically see the cost of goods sold or COGS in their income statement, but what exactly is it? For product-based businesses, it’s essential to understand, track and manage your COGS. As your catalogue grows and becomes more complex, so does staying on top of COGS.
In this article, we’ll explain the ins and outs of COGS as well as how you can accurately calculate it. Then, we’ll go into how you can automatically sync your COGS to your accounting software. Finally, we go through strategies for keeping accurate numbers across all your systems and ideas for reducing COGS.
What is the cost of goods sold (COGS)?
The COGS or Cost of Goods Sold is the direct cost retail businesses including e-commerce businesses need to pay to sell products. This includes the cost of the product itself such as direct labour, manufacturing, raw materials, vendors and suppliers. On top of that, it includes the freight costs and duties and fees associated with getting the product to your warehouse.
The freight costs you pay to ship products to customers as well as research and development costs aren’t included in COGS. Similarly, though packaging of the product itself is included, packaging involved with shipping products to customers is not included. Indirect costs of selling goods such as marketing are not included.
Why does COGS matter to my business?
Knowing your COGS and getting it as accurate as possible is essential to a variety of metrics key to e-commerce businesses. First and foremost, COGS is part of the gross profit margin formula: Gross Margin = Sales – COGS. With gross margin being such a critical KPI, getting your COGS right is a must.
When you calculate COGS on a product, SKU or category level, you get to build deeper insights into what products are profitable. Plus, you can compare data between different periods to see how profitability is changing. From here, you can change your pricing strategies or strategies for marketing, purchasing, etc.
Finally, having a precise record of your COGS is important for tax purposes. You need it to stay compliant and avoid any potential fines. Additionally, COGS is considered a business expense, meaning in most cases, you won’t be taxed for it and your revenue will be reduced. Hence, higher COGS isn’t always negative depending on your goals.
How do you calculate COGS for e-commerce
COGS is calculated for the period on the income statement based on the formula: COGS = Beginning Inventory + Purchases – Closing Inventory. Purchases include any costs for labour, materials, supplies or costs to suppliers and vendors. It’s useful to understand your COGS at a product, SKU and category level as well so that you can build deeper insights.
For example, let’s say the beginning inventory for one of your products is $100,000 (this should be the same value as the closing inventory from the previous period) and the closing inventory is $150,000. During this period, you spent $250,000 to pay the supplier and freight costs to get products to your warehouse. The COGS would be 100,000 + 250,000 – 150,000 = $200,000.
Maintaining accurate inventory levels
Both when looking at your COGS as a whole and when looking at it on a finer level, it’s crucial to have a reliable inventory management system for your e-commerce business. In order for your COGS to be recorded correctly, you need to have timely and accurate data on inventory levels. This is important in making more informed decisions as well as for tax reasons.
Using an inventory management system such as Unleashed Software or DEAR Systems can help you to maintain accurate inventory levels across multiple systems. However, even though these systems automate many workflows, it can be useful to manually go through your inventory and do a stocktake on a regular basis.
How to sync your COGS to your accounting software
Now that you understand how COGS is calculated and know how to ensure it’s recorded precisely, you can consider automating the process of entering your COGS into your accounting system. This is made easy if you have a cloud-based accounting system such as Xero or QuickBooks Online. All you need to do is use an accounting integration.
For instance, you can use one of Amaka’s accounting integrations such as Shopify to Xero or Shopify to QuickBooks Online. Sales transactions and COGS are automatically synced from your e-commerce platform to your accounting software on a daily basis. If you have to process a refund, the integration automatically makes necessary adjustments.
How to you reduce COGS and increase margins
If your goal is to reduce your e-commerce business’s COGS, there’s a number of ways you can go about it. Depending on your situation, reducing COGS can make more sense than increasing prices (or you could do both). We’ll go through a few of the key strategies, however, please note that not all of these will be relevant to you.
- Take advantage of economies of scale where possible. Whether your products are from a supplier or you’re manufacturing them yourself, as your store starts to grow, look into getting a discount for buying in bulk. Negotiate, negotiate, negotiate!
- Change suppliers, materials or manufacturers entirely. If negotiating with the businesses you’re currently working with on the basis of economies of scale is working, it’s worth looking at alternatives. This could mean going for a supplier with cheaper shipping, a lower cost material for your manufacturing or offshore manufacturing.
- Look at the products that aren’t selling. Even if these products have a great margin, they’ll negatively impact your COGS if they’re just sitting on the shelves. Look at ways you can decrease turnover rates or get rid of these products entirely.
- Eliminate bottlenecks and errors in your supply chain. You might find a bunch of potential improvements after analysing your supply chain. For example, materials being damaged, goods being lost with your current shipping process or inefficiencies with labour.
- Automate as many workflows as possible. As an accounting automation solution, we can’t forget about the importance of automation. If labour costs make up a large part of your COGS, automation can make a massive difference. This could involve replacing a process with a machine or introducing software that helps your team be more efficient.
Key takeaways on managing COGS for e-commerce
Managing COGS for e-commerce businesses all starts with having accurate data. From there, you can better drill down on performance at a SKU, product or category level, or even compare between periods. This allows you to make better decisions, whether that be to work on your COGS, change your pricing or try out different strategies.