Cost of sales (synonyms: cost of goods sold, cost of products sold) represents the cost that company has in order to produce the goods. It includes the materials needed for the product combined with labor costs, but it doesn’t include other possible expenses such as distribution and administrative costs.
Cost of sales for goods that are not produced within the company but bought in order to resell includes price the product is purchased for plus other expenses connected to the purchase process.
Importance for the business
Knowing the cost of sales for every product that a company produces or buys for reselling is important for the company’s profit. It can determine how many products need to be sold in order to achieve the outlined profit.
Not calculating cost of sales can often lead to actually losing money on some product. In other cases, the earnings that remain after the basic costs are covered often end up covering other expenses which are not included in the cost of sales. In other words, for the product to be profitable, there should be an actual profit left after all the costs made by producing it.
As if things are not complicated enough, not every profit is the same. For example, company’s goal is to earn $10.000 per month (pure profit). If the profit from one product is $1, than 10.000 products need to be sold. In case the profit from one product is $100, the number of products that need to be sold falls down do 100. It’s easy to see the principle behind this: the bigger the profit of an individual product, the less products need to be sold.
Determining the final price, hence, depends on many factors:
the business volume – will the company be able to sell enough products with the lower price so it doesn’t lose money?
the competition – prices must be competitive because people wouldn’t pay more for the same quality if they don’t have to
the market size – with large market it’s a bit easier to assume there will be more sales, which means higher business volume, which further means the possibility for reducing prices and attracting customers
Type of industry – making cars and making pens can never work at the same principle; understanding the industry under which company works can be important for predicting previously mentioned price factors