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How to Calculate Cost of Goods Sold (COGS) in QuickBooks

Written by Santiago Poli on Dec 21, 2023

Tracking cost of goods sold (COGS) is critical for understanding profitability, yet many small businesses find calculating it in QuickBooks challenging.

Luckily, with the right setup you can accurately track COGS in QuickBooks without complicated inventory features.

In this post, you'll learn step-by-step how to configure QuickBooks to automatically calculate COGS using purchase orders, bills, and sales receipts. You'll also discover best practices for maintaining accurate COGS over time through periodic reconciliations.

Introduction to Calculating COGS in QuickBooks

Calculating Cost of Goods Sold (COGS) accurately is critical for understanding the true profitability of your business in QuickBooks. Tracking COGS allows you to properly value inventory, analyze pricing decisions, optimize cash flow, and reduce tax liability. This guide will provide an overview of what COGS is and the key reasons to calculate it correctly in QuickBooks.

Defining Cost of Goods Sold (COGS)

Cost of Goods Sold (COGS) is the direct costs attributable to the production of goods sold by a company. This includes the cost of materials, direct labor, and overhead costs directly related to production. Simply put, it's the cost to actually make the stuff you sell. Tracking COGS accurately allows you to value remaining inventory properly and determine the actual gross profit from sales.

Key Reasons to Properly Calculate COGS

There are a few important reasons why properly calculating COGS is critical for any manufacturing, wholesale, or distribution company:

  • Better Pricing Decisions: Understanding accurate COGS allows you to set optimal pricing to achieve target gross margin goals. This ensures prices both cover true costs and remain competitive.

  • Reduced Tax Liability: Overstating COGS reduces taxable income so it's imperative to capture proper costs to avoid IRS scrutiny.

  • Improved Financial Reporting: Accurate COGS lead to true gross profit, allowing better insights into production costs and operating performance.

Properly tracking COGS is crucial for inventory-based businesses. Doing so allows optimum pricing, inventory valuation, and profitability analysis in QuickBooks. The next sections will cover specifics on calculating COGS based on inventory method.

How do you calculate cost of goods sold COGS?

At a basic level, the cost of goods sold formula is:

Starting inventory + purchases − ending inventory = cost of goods sold

To make this work in practice, you need a clear and consistent approach to valuing your inventory and accounting for your costs.

Here are the key steps to calculate COGS in QuickBooks:

  • Set up inventory items and enable inventory tracking in QuickBooks. This allows you to assign costs to specific inventory items.

  • Enter purchase transactions for inventory items. This builds up the "purchases" component.

  • Conduct a physical inventory count at least once a year. The ending inventory value gets deducted from purchases.

  • Run inventory reports. The main one is the Cost of Goods Sold report, which calculates COGS based on those inventory transactions.

  • If you sell services instead of physical goods, you can enable the "Cost of Goods Sold" account to track labor and materials costs for jobs.

The key is consistency in how you value inventory and record related transactions. With some initial setup in QuickBooks, you can then leverage built-in reports to accurately calculate COGS. Monitoring COGS trends over time can also provide insights into pricing, profits, and operational efficiency.

What is the formula to calculate cost of goods available for sales COGS?

The cost of goods available for sale is calculated based on the following formula:

Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold (COGS)

Here's a breakdown of what each component means:

  • Beginning Inventory: The value of unsold inventory at the start of the accounting period. This would be the ending inventory value from the prior accounting period.

  • Purchases: The cost paid for inventory purchased during the current accounting period. This includes raw materials, components, and finished goods.

  • Ending Inventory: The value of unsold inventory still remaining at the end of the accounting period.

  • Cost of Goods Sold (COGS): The total direct costs attributable to the production of goods sold during the accounting period. This is calculated by taking the cost of goods available for sale and subtracting the value of unsold ending inventory.

So in simple terms, you take the previous period's leftover inventory, add what you purchased, then subtract what's still left over, and the difference is the cost basis for the goods you sold during that period.

Tracking COGS allows you to accurately value inventory and determine the actual profitability of sold goods. This is a key metric businesses monitor closely.

In QuickBooks Online or Desktop, the cost of goods sold is automatically calculated based on your inventory transactions. You can view the COGS value on reports such as the Profit & Loss and Balance Sheet. Monitoring it regularly enables better financial control.

What is the difference between cost of goods sold and an expense in QuickBooks?

Expenses are the ongoing operational costs of running a business, like rent, utilities, office supplies, etc. These are indirect costs not directly tied to the production or sale of specific products.

Cost of goods sold (COGS), on the other hand, refers specifically to the direct costs of materials and labor to manufacture products or purchase inventory for resale. COGS directly contributes to generating revenue through sales.

Here are some key differences:

  • Expenses reduce net income and are deductible for tax purposes in the same period they are incurred, regardless if any sales occur.
  • COGS is directly correlated with sales revenue. It is only recorded when inventory or products are actually sold, not when purchased.
  • Expenses are usually periodic fixed costs, while COGS varies directly with production or sales volume.
  • Common examples of expenses include salaries, advertising, rent, utilities, vehicle fuel, etc.
  • COGS refers to the cost of raw materials, direct labor, manufacturing overhead, and purchased merchandise directly tied to the items sold.

In QuickBooks, properly categorizing costs as expenses or COGS is important for accurate financial reporting and tax compliance. COGS directly reduces gross profit to determine net income from sales. Keeping expenses and COGS properly differentiated is key.

What is the difference between cost of sales and cost of goods sold?

The key differences between cost of goods sold (COGS) and cost of sales are:

  • Cost of goods sold (COGS) refers specifically to the direct costs attributable to the production of goods sold by a company. This includes the cost of materials, direct labor, and overhead costs directly related to production. COGS does not include operating expenses that are not involved in production, like marketing or administrative costs.

  • Cost of sales is a broader term that encompasses COGS plus all other expenses involved in selling products. This includes things like sales commissions, shipping charges, and sales returns in addition to the direct production costs captured under COGS.

In summary:

  • COGS only covers direct production costs
  • Cost of sales includes all costs related to selling products - both production and non-production expenses

So COGS is a component of cost of sales. While COGS focuses strictly on manufacturing-related expenses, cost of sales incorporates other expenditures tied to getting products to customers. Understanding the difference can help businesses allocate costs more precisely for financial reporting and analysis.

Understanding How QuickBooks Calculates COGS

QuickBooks provides several methods for tracking cost of goods sold (COGS), depending on whether you use inventory items or non-inventory items.

At a high level, QuickBooks calculates COGS based on the following:

  • Inventory items: When you sell an inventory item, QuickBooks decreases the inventory asset account and increases COGS automatically based on the item's cost.

  • Non-inventory items: You need to manually enter bills or expenses that make up COGS. QuickBooks sums these into a COGS account.

QuickBooks Cost of Goods Sold vs Expense

The key difference between COGS and expenses in QuickBooks is:

  • COGS: Direct costs tied to producing or purchasing goods sold during a period. Flows to the income statement.

  • Expenses: Operational costs not directly tied to goods sold. Flows to the income statement below gross profit.

Expenses include things like rent, utilities, marketing costs, etc. While COGS makes up goods that become part of inventory.

Properly separating the two is key for accurate financial reporting.

Tracking COGS without Inventory in QuickBooks

For service businesses and those not using inventory items in QuickBooks, you can manually track COGS using other accounts:

  • Enter bills: Assign bill line items to a COGS account.
  • Write checks: Assign check expenses to a COGS account.
  • Enter credit card charges: Assign charges to a COGS account.

At the end of each period, run a COGS report to sum all transactions assigned to COGS accounts. This provides the manual figure for COGS without relying on inventory.

The key is ensuring you accurately capture all costs that should flow into COGS rather than expenses. Consult an accounting professional if unsure on proper COGS classification.

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Setting Up QuickBooks for COGS Calculation

To accurately calculate cost of goods sold (COGS) in QuickBooks, some initial configuration is required. Here are key steps when first setting up your QuickBooks file:

Configuring Inventory Items for COGS Tracking

When selling inventory items, proper setup is critical for correct COGS calculations:

  • Enable the inventory feature in QuickBooks. This allows you to track stock quantities, values, and assign costs to specific items.

  • Create separate inventory parts/assembly items for all products you manufacture or assemble. QuickBooks will use these costs rolls up into the final inventory item.

  • Assign carefully calculated standard costs to each inventory item. This provides the basis for COGS calculations.

  • If using average costing, update standard costs periodically to reflect new purchase costs. This keeps COGS closer to actual costs.

  • For purchased inventory, record costs accurately on purchase transactions. This flows the vendor costs into inventory.

Following this best practice inventory setup will ensure QuickBooks has the accurate cost data to calculate reliable COGS expense on sales transactions.

QuickBooks Cost of Goods Sold without Inventory

For service companies or businesses that do not track inventory in QuickBooks, you can still calculate COGS using other methods:

  • Manually enter COGS at the transaction level for each sale. You can estimate COGS costs based on records outside QuickBooks.

  • Allocate COGS by percentages. Record total expenses to track in Other Expense accounts, then assign a % to COGS at the transaction level based on your business model.

  • Use averages from financial history. Calculate average COGS over past periods and apply the same % per transaction. Update periodically.

The key is ensuring you have expenses that make up COGS recorded, so you can accurately estimate COGS portions for sales without inventory tracking in QuickBooks.

Managing Purchase Orders and Bills in QuickBooks

Purchase orders and vendor bills are important components of tracking inventory costs and calculating COGS accurately in QuickBooks.

Creating Purchase Orders for Inventory Management

Purchase orders in QuickBooks provide an organized way to manage ordered inventory before receipt. Key details to include on purchase orders are:

  • Vendor details like name, contact info, payment terms
  • The item(s) ordered, quantity, cost
  • Expected delivery date

Creating purchase orders pre-records your inventory orders so that when the items are received, QuickBooks can automatically update your inventory quantities on hand.

Recording purchase orders also ensures you have committed costs tracked against inventory before receipt. This allows QuickBooks to accurately calculate COGS later when you sell inventory items.

Entering and Paying Bills to Reflect COGS

Once inventory is received, the next step is entering a bill in QuickBooks to record the vendor invoice and formalize the actual inventory costs.

Key details to include on vendor bills are:

  • Linking the purchase order (if used)
  • Entering final item quantities and costs
  • Selecting the correct expense account (usually Inventory Asset or COGS)

By linking bills to purchase orders, QuickBooks can compare expected vs. actual inventory costs and quantities. Entering final costs ensures your inventory asset values and eventual COGS expense are accurate.

Finally, when paying bills be sure to select the correct payment account so cash outflows that affect COGS hit the right financial statement accounts.

Following this purchase order -> bill -> payment flow helps QuickBooks seamlessly track inventory costs and COGS financial impacts.

Recording Sales and Calculating COGS in QuickBooks Online

QuickBooks Online provides a streamlined process for tracking inventory sales and automatically calculating cost of goods sold (COGS).

Invoicing with Inventory Items in QuickBooks Online

When creating sales invoices in QuickBooks Online, you can add inventory items from your item list. As the inventory items are invoiced and converted to sales, QuickBooks will automatically:

  • Decrement the inventory quantity on hand based on the sale
  • Assign the inventory item's purchase cost to COGS
  • Calculate COGS for the sale based on the total cost of inventory items

This allows you to easily track remaining inventory and record COGS without manual calculations.

For example:

  • You purchase 10 units of Item A at $5 per unit, so inventory purchase cost is $50
  • You then sell 5 units of Item A for $10 per unit, totaling $50 in revenue
  • QuickBooks will reduce Item A quantity on hand from 10 to 5
  • It will assign $25 of the original $50 purchase cost to COGS (5 units at $5 cost per unit)
  • So net income will be Revenue $50 minus COGS $25 = $25

The key things to ensure:

  • Inventory items are properly set up with purchase cost
  • Sales invoices use inventory items rather than expenses

Correctly setting up and linking inventory items allows QuickBooks Online to automatically record COGS based on the inventory sales.

Handling Sales Returns and Adjusting COGS

If inventory items are returned by a customer, you need to account for the return and adjust COGS accordingly.

In QuickBooks Online, you can handle returns using:

  • Credit memos linked to invoices - Best if the original invoice is available
  • Item receipts - For returns without original invoice or new units back into inventory

Using credit memos linked to invoices will automatically adjust the associated COGS from the linked sales transaction.

For other returns, item receipts put the inventory back on hand without a direct COGS adjustment. You then need to manually account for the change in COGS depending on the specific situation.

So proper tracking and handling of inventory returns ensures you can accurately record adjustments to inventory and COGS in QuickBooks Online.

Understanding COGS Reports in QuickBooks

QuickBooks offers several reports to analyze cost of goods sold (COGS) results and trends over time. These reports provide visibility into the key drivers behind COGS expenses across products, customers, and other business segments.

Cost of Goods Sold Report in QuickBooks Desktop

The Cost of Goods Sold report in QuickBooks Desktop shows a breakdown of all the costs that make up COGS for a specified period. This includes:

  • Beginning inventory - Value of inventory at the start of the period
  • Purchases - Total amount spent on inventory purchases
  • Purchase related expenses - Additional costs of acquiring inventory like freight and customs fees
  • Ending inventory - Value of inventory still on hand at the end of the period

Subtracting the ending inventory from the beginning inventory plus purchases provides the cost of goods sold amount.

Reviewing this report periodically enables analyzing the products and vendors that make up the largest share of COGS. It also helps identify unusual fluctuations that may need further investigation.

Profit and Loss by Class and COGS Insights

The Profit & Loss by Class report groups income and expenses by business segments like products, customers, jobs or classes.

Classes in QuickBooks provide a way to tag transactions to specific divisions or profit centers. Defining classes for major product lines or customer groups allows viewing COGS and profits by those categories.

For example, a clothing manufacturer can set up separate classes for “shirts”, “pants”, “jackets” etc. The Profit & Loss by Class report will then display COGS and net income by each clothing type.

This enables identifying the most and least profitable products or customers to guide pricing and production decisions. The COGS insights highlight products with shrinking margins so loss-making items can be adjusted or discontinued.

Best Practices for Accurate COGS in QuickBooks

Accurately calculating cost of goods sold (COGS) is critical for understanding profitability. Here are some tips for properly configuring QuickBooks to track COGS:

Ensuring Accurate Opening Balances for COGS

When first setting up your QuickBooks file, carefully enter the total value of your inventory on hand. This establishes the opening balance that QuickBooks will use to deduct inventory costs.

  • Conduct a physical inventory count and value all items at cost before setup
  • Enter quantity-on-hand and unit cost for each inventory item
  • Set inventory asset accounts to track COGS

With accurate opening balances, QuickBooks can correctly calculate COGS as additional inventory is purchased and sold.

Conducting Regular Inventory Reconciliations

It's important to periodically compare QuickBooks to your actual inventory levels. Count products on shelves and double check costs to ensure recorded amounts match reality.

  • Perform full inventory reconciliations at least once per year
  • Investigate any discrepancies and make adjusting entries
  • Spot check high value goods monthly for added assurance

Keeping inventory data synchronized means COGS stays up-to-date over time as sales occur and new inventory is acquired.

Following these best practices will help guarantee reliable COGS figures and confidence in profitability assessments. Let QuickBooks work for you by taking time to manage inventory data.

Conclusion and Next Steps in COGS Calculation

Calculating COGS accurately is critical for understanding the true profitability of your business. Here are some key takeaways:

  • COGS represents the direct costs incurred in manufacturing or purchasing products sold by your company. Tracking COGS allows you to determine your gross profit margin.

  • In QuickBooks, you can calculate COGS automatically if you are using inventory tracking. If you do not track inventory, you will need to set up accounts to track COGS expenses manually.

  • Key COGS accounts to track include materials, labor, manufacturing overhead, and purchasing costs related to products sold. Make sure to only include direct costs of sold goods, not operating expenses.

  • Review your COGS at least monthly and compare it to your sales revenue to analyze your profit margins over time. Breaking down COGS by product line can also provide insights.

  • For more help understanding and calculating COGS in QuickBooks, check out their online user guides and community forums, or consider working with an accountant. Getting COGS right is vital for accurate financials.

Accurately tracking and reporting COGS is essential for any product-based business using QuickBooks. Taking the time to understand what costs should be included and how to set up COGS accounts properly will pay dividends through better financial visibility and decision making.

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