The cost of goods manufactured or COGM is a business concept that refers to the costs involved in manufacturing a product. In practice, most businesses track their actual COGM through inventory and prepare estimates for future periods.
Understanding the difference between manufacturing costs and non-manufacturing costs is essential to understanding how you arrived at your final sale price from a marketing perspective.
The total costs involved in producing a finished product are divided into two categories: direct and indirect.
Direct Manufacturing Costs: Direct manufacturing costs refer to those expenses directly associated with production, such as materials or labour.
Indirect Manufacturing Costs: Indirect manufacturing costs refer to Overhead expenses that cannot be easily identified with any particular service or department presentation, such as depreciation.
The Concept of Manufacturing Cost
Manufacturing costs are one of the components that go into a business’ gross income statement, commonly known as the P&L.
This financial statement separates business expenses into variable and fixed costs. Manufacturing costs represent those costs that increase or decrease proportionately to the total number of units produced within a given time frame.
Manufacturing costs are variable because they can be directly linked to production output. Variable manufacturing overhead includes direct labour, material quantity usage, machine-hour usage, subcontracting fees, product testing fees, etc.
Fixed manufacturing overhead is associated with items like rents, administrative salaries, insurance premiums, etc.
In addition to being an essential part of the balance sheet, COGM information is also used for managerial accounting purposes.
COGM can be used to determine a product’s cost-efficiency, which is the ratio of units produced to total manufacturing expenses.
Sales data from multiple time frames can also be used with COGM information to forecast future costs and production volume.
In many cases, manufacturers who experience significant growth will hire new employees, expand their facilities, and purchase more company equipment.
In turn, they may have to manage more supply components throughout various states or even internationally. This added complexity often results in more administrative tasks being necessary for maintaining accurate COGM records.
The biggest pitfall of incorrectly tracking inventory levels is that it might lead you to charge customers too much or too little for your products.
If your COGM figures aren’t accurate, you might not have an idea of what an item is worth once other departments have worked on it. To calculate the cost of goods manufactured (COGM), divide direct manufacturing costs by the number of units produced.
For example, if a company’s total direct materials costs are $100,000 and they manufacture 2,000 items during the period, their COGM would be $50 per unit.
Errors in costing can lead to disputes with suppliers regarding invoices, missed deadlines due to production line stoppages or manufacturing delays, lost customer goodwill, missed retail sale opportunities, etc.
The most effective way to avoid these problems is to keep an eye on incoming orders and monitor how many units have been completed.
If the number of items being produced doesn’t match what has already been shipped out, you can use a COGM calculator to determine where the problem occurs.
The cost of goods manufactured (COGM) is a key performance indicator for companies producing tangible products.
It consists of the total expenses required to create a product, from raw materials to finished stock ready for sale.
The number can be used as a benchmark for management decisions and price setting and vary depending on the business model utilised.
COGM is only an estimate, not an exact figure. Any difference between standard and actual COGM must be attributed to either under or overestimation (including income)
The Manufacturing Process
The manufacturing process can be broken down into several stages, each one requiring costs to be incurred.
There may be costs associated with labour and materials; then, at the distribution stage, transportation expenses are incurred; finally, at the retail level, the stock is added up against sales revenue to produce COGM.
Because of these variations in the size of business models, different figures for COGM will be produced by companies operating on similar models but with varying scales of operation.
COGM is mainly used as a profitability indicator. A low cost per unit might suggest that more units could be sold without losing money.
The primary purpose of tracking COGM is to identify areas where improvements can be made to reduce the overall cost base.
The COGM Calculation can Include
To calculate COGM correctly, it is necessary to write down all purchases made during production by adding up every cost associated with manufacturing a product. This might include transport fees, raw materials, power supply, and other necessary expenses.
Direct labour costs: Those going to employees directly involved in the product’s manufacture and overhead expenses such as equipment use or office expenses incurred during production.
Average cost method: – the average cost per unit is used to calculate production costs. This can be calculated by dividing stock at retail/distribution level COGM by the number of units in stock. I
f fewer units are stocked, more will need to be produced, increasing production costs. Conversely, if there are more units in stock, less must be made next time around, reducing costs associated with production.
Specific identification costing: – Under this model, every item has a special purchase price entered against it during its manufacture.
The difference between the purchase price and selling price determines how much inventory remains or has been incurred as expense COGM calculation should occur when an item is sold, so both figures are accurate.
This is generally impractical for companies with significant stock levels that might never sell COGM calculation is only carried out on items sold.
Standard cost method: – an average cost per unit can be estimated by comparing historical costs against current prices in the retail/distribution stage of the manufacturing process.
Challenges of Cost of Goods Manufactured
The biggest pitfall of incorrectly tracking inventory levels is that it might lead you to charge customers too much or too little for your products.
To calculate the cost of goods manufactured (COGM), divide direct manufacturing costs by the number of units produced. For example, if a company’s total direct materials costs are $100,000 and they manufacture 2,000 items during the period, their COGM would be $50 per unit.
Errors in costing can lead to disputes with suppliers regarding invoices, missed deadlines due to production line stoppages or manufacturing delays, lost customer goodwill, missed retail sale opportunities, etc.
The most effective way to avoid these problems is to keep an eye on incoming orders and monitor how many units have been completed. If the number of items being produced doesn’t match what has already been shipped out, you can use a COGM calculator to determine where the problem occurs.
Why is Standard Cost of Goods Manufactured Important?
Easy to see where COGM savings can be made through better planning and more efficient processes that reduce labour time required per unit.
Using CoPS, it is possible to specifically allocate each employee into their own unique production process stream requiring minimal effective supervision and allowing an estimated 50% reduction in labour costs.
For smaller companies, this may be higher than actual overheads incurred as they lack detailed records of factory costs and often end up using out-of-date figures from previous periods to calculate their standard overhead rates.
This is more common in manufacturing industries that employ a lot of labour like textiles and furniture production.
The cost of goods helps in;
- Standard Costing allows for better planning as managers have a common format to work with when determining how much products should cost and what resources are needed to create the product. This allows them to determine whether they need more resources or sell their products at a reasonable price.
- Standard Costing can be used to compare individual products or services to similar items sold by competitors. This allows managers to accurately determine which product would be the most successful based on its cost to produce and profit margin and how it compares with similar products made by competitors.
- Standard costs are used in the budgeting process to forecast future revenue and expenses for individual projects more precisely. This is especially important when companies are projecting financials for an upcoming fiscal year. Standard costing usually becomes more detailed during the month of quarterly reports, allowing managers to better predict actual performance against plans.
- Standard costs help avoid overpricing goods by adding extra charges that may not be incurred in reality. It is a standard rate set across all companies in an industry, so it is fair for everyone involved. It also helps companies calculate accurate prices for new customers because previous sales data can estimate the actual costs of producing each item.
Preparation for Calculating the Cost of Goods Manufactured
Use industry average overheads per worker so divide total unit COGM by standard overhead cost per worker to get a typical cost for each unit produced -for smaller companies, this may be higher than actual overheads incurred as they lack detailed records of factory costs and often end up using out of date figures from previous periods to calculate their standard overhead rates.
This is more common in manufacturing industries that employ a lot of labour like textiles and furniture production.
Can estimate standard hourly rate by multiplying actual company overheads per worker/machine by that of an industry average
COGM standard cost = COGM / (standard overhead cost per machine + Standard overhead cost per worker).
COGM standard cost = COGM / (1 + std_OH_rate * std_OH_rate).
Inventory Tracking: Inventory tracking is a term used to describe the process of recording any changes in inventory quantities or values from one reporting period to another. For a business to determine the effectiveness of its operations, it must use reliable information about current inventory levels and costs. This allows accurate calculations of financial results resulting from management decisions.
Cost of Goods Manufactured (COGM): Calculated by taking direct materials + direct labour + any other manufacturing costs incurred during the production process. Allocated over units produced = unit cost per unit produced.
Actual Overhead Costs: Calculated by allocating the COGM over units produced, including all other costs such as indirect labour, factory depreciation cost, etc.
Standard Overhead Costs – calculates the total COGM divided into an overhead rate (calculated using historical data) then multiplied by the number of units to get the standard overhead cost for each unit.
To achieve this, government regulations must be created and implemented requiring companies to record input transactions directly into their accounting system.
Calculate manufacturing overhead cost (indirect labour and other manufacturing costs) by multiplying the total direct labour hours by a predetermined rate for allocating indirect costs into production.
The predetermined rate should be calculated from previous months/years’ accounts. Manufacturing overhead = direct labour * predetermined rate
Automating Calculations of Cost of Goods Manufactured
COGM calculator Automate COGM calculations Fee-based apps Use fee-based apps instead of free ones Work with an accountant Consult with an accountant before automating anything Expanded facilities Expand existing facilities Adding new equipment Purchasing new tools & equipment Increased inventory levels Keep up/monitor inventory levels Delays Missed deadlines Lost customer goodwill Customers become tired of waiting Disputes Invoices Can result from incorrect payment amounts and incorrect inventory and COGM numbers.
As mentioned above, COGM information is used for managerial accounting purposes. Sales data from multiple time frames can be used with COGM information to forecast future costs and production volume.
In many cases, manufacturers who experience significant growth hire new employees, expand their facilities, and purchase more tools and equipment.
The biggest pitfall of incorrectly tracking inventory levels is that it might lead you to charge customers too much or too little for your products.
If your COGM figures aren’t accurate, you might not have an idea of what an item is worth once other departments have worked on it.
To calculate the cost of goods manufactured (COGM), divide direct manufacturing costs by the number of units produced.
Errors in costing can lead to disputes with suppliers regarding invoices, missed deadlines due to production line stoppages or manufacturing delays, lost customer goodwill, missed retail sale opportunities, etc.
Examples
The formula to calculate the cost of goods manufactured is:
If Company A’s overhead costs are reduced from $60 to $40 per unit produced, this will result in a lower COGM, which would increase their bottom line.
The company would either break even or make a slight profit because we know the cost of goods manufactured, or COGM is a business concept that refers to the costs involved in manufacturing a product. In practice, most businesses track their actual COGM through inventory and prepare estimates for future periods.
Understanding the difference between manufacturing costs and non-manufacturing costs is essential to understanding how you arrived at your final sale price from a marketing perspective. The total costs involved in producing a finished product are divided into two categories: direct and indirect.
The formula for the cost of goods sold is:
A business manufactures a product that costs $50 to produce. Sales revenue from the sale of this item was $75. How much did the company earn in gross margin?
Assuming no other costs involved, such as materials or labour, the company would have earned $25 in gross margin.
COGS = 75
COGM = 50
Gross Margin = COGM – COGS = 50-75= -25
To understand why this makes sense, we can examine both sides of the equation:
Combined: 100% (100+0) > 75% (0+75) and 100% (100+0) < 25% (100+25)
COGS = 75 > 0, so the profit margin is negative 25% (-25%)
COGM Standard Price = COGM / (Standard Overhead Cost per Machine + Standard Overhead Cost per Worker)
COGM standard price = 100,000 / ([2000+1400])
COGM standard price 100,000 / 3400
If Company A’s standard cost for each unit of product is $67.69, what are the difference between the company’s actual cost this month and their standard cost? The company’s actual cost will be $67.69 minus its standard cost, which is $44.31.
This means that the company had a cost of goods sold for this month of $67.69 minus their standard cost, which is a loss in gross margin.
The formula to calculate the difference between actual and standard cost is:
COGS Actual Price = COGS / (Standard Overhead Cost per Machine + Standard Overhead Cost per Worker)
COGS actual price = 100,000 / ([2000+1400])
COGS actual price 100,000 / 3400
COGS Actual Price = 44.31
To lower costs by 10%, Company A finds that it can reduce its overhead costs from $60 to $40 per unit produced. What effect will this have on the company’s profit margin?
The profit margin is the difference between the selling price and the cost of goods sold.
COGS = 75
Standard Overhead Cost per Machine = 2000
Standard Overhead Cost per Worker = 1400
COGM Standard Price = COGM / (Standard Overhead Cost per Machine + Standard Overhead Cost per Worker)
COGM standard price = 100,000 / ([2000+1400])
COGM standard price 100,000 / 3400
Keynote
- Producing products with similar materials but different unit prices will mean different COGM’s for each product.
- If raw materials vary depending upon what happened to be available at production, enormous fluctuations in COGM can occur.
- Suppose a product requires that a certain amount of raw materials be included with every unit produced. In that case, the same will happen with COGM as raw material price fluctuations affect COGM more than units produced.
