Let's explain some business jargon

Has your bookkeeper or accountant ever started talking to you out of nowhere about gears when you're reviewing your monthly or yearly reports?

Maybe the exact word they used was "CoGS" - a bit of jargon which is a shortened version of some other jargon: Cost of Goods Sold.

Why's that phrase important to you as someone who sells... well... anything?

Let's start with a general definition of what that phrase actually means. Cost of Goods Sold (sometimes Cost of Sales for more service-focused businesses like contractors or attorneys) is a way to think of how much the products or services that you sell cost you *just to get to your shelf* or just to make good on for your client.

What does that look like in real life?

For inventory-based businesses, the biggest part of CoGS is usually the actual cost of your inventory. You have to buy stuff to resell it, after all. You also often have to pay to have it shipped to your store or fulfillment center. You may have to pay for packaging and printing as well, if you produce those items yourself. Your raw materials are part of your CoGS if you actually make the stuff you sell in-house. All those costs are required to get your products onto the shelves where your customers can buy them - they can't really be sold *before* you've incurred those costs.

Service businesses can be a little more abstract on this front. Here, you can think of Cost of Sales as the things which are *directly required* for you to deliver on your clients' projects. As a contractor adding an addition to a house, that might include permits, contract labor for that particular job, supplies, subcontractors, etc etc. Without those specific costs, you cannot deliver the specific result you're being paid for.

So what's *not* Cost of Sales? Generally it's things that you use for more general purposes in your business. Your office manager, who provides administrative support to your entire business, doesn't count as a Cost of Sales or CoGS. Your accounting and payroll services aren't directly related to getting your products ready for delivery. Rent and work trucks (and expenses related to work trucks) are rarely Costs of Sales because they'll usually be used for many different purposes across all your business activities. Those are generally all overhead costs - what it takes to administer your business, rather than to produce what your business sells.

Now if you're still here, let's finally talk about why this might matter to you :P

CoGS or CoS can be a very powerful way of looking at one segment of your business' expenses and how it impacts your overall financial health. How big a difference can improving this number make?

Let's look at a retail business selling widgets via an online store. They spend $80,000 buying widgets and shipping those to their warehouse every month. That $80k is their CoGS for the sake of this example. If they can sell those widgets for a total of $100k, that means that they have a margin (pardon the extra jargon) of $20k. That margin now has to fund *the entire rest of their business operations*, from administrative costs to warehouse workers to R&D to the cash the owner is able to take out of the business every month.

What if we improve that CoGS number ($80k) by just 1% - maybe by negotiating better terms with a supplier or reducing shipping costs to your warehouse?

That brings those monthly CoGS down to $79200. Only $800 per month, but that's almost $10k per year. If *nothing else changes* that means that you have an extra $10k every year to develop new supplier relationships, to hire another part timer or pay your team better, to invest in improving other parts of your business, or it's an instant $10k raise for yourself.

For service businesses like attorneys, a large part of CoS is often billable hours - the payroll expense you incur as your team of experts dedicates their time to delivering services to your clients. Similarly, those billable hours are where most of your income will come from because that's how you deliver on what you're selling. But have you ever paid close attention to how many *unbilled* hours your team is spending on the clock every month? Here, Cost of Sales can be a great tool to separate revenue-generating time from other payroll expenses so you can get a better sense of how *efficient* your business is and whether your team is spending too much time *managing* work instead of *doing* work.

Contractors tend to fall somewhere in the middle of these two extremes, with needs and considerations from the inventory side as they buy and use materials and from the service side as they manage labor and subcontractors.

Are you convinced? Could looking at what you pay just to sell your product or service help you understand how you're doing? Could it save your business if you've been struggling to find the leaks in your finances?

It's definitely a great place to start.

Talk to your bookkeeper about how you can do this better. Talk to your advisor about the action you can take with this knowledge.

If you don't have experts who can or will help you on those fronts, give us a call. We'll be happy to chat.