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Cost
of Goods Sold
By Marc Weiss, Managing Director of Management One®
When reviewing your financial statement there are several
key elements that determine profit:
| 1. |
Net
sales- the amount of sales during the reporting
period. This amount reflects the total value of
merchandise sold to your customers. Markdowns are
subtracted and sales tax is not included in Net
Sales. Some other caveats to remember is that gains
or losses from investments or from charging customers
for alterations are not included in Net Sales. This
income is added below as Other Income. Also, Net
Sales assume an accrual basis for accounting. For
example, if an item is sold on a house charge that
item is included in Net Sales even though the revenue
has not been fully collected. Should the monies
never be collected then that becomes an expense
when it is determined uncollectable. |
| 2. |
Cost
of Goods Sold- this is sometimes referred to as
Cost of Sales. Cost of Goods Sold is what it actually
costs a retailer for the goods that he sold during
a given period. The correct formula for determining
Cost of Goods Sold for merchandise is:
a.Beginning inventory at cost
b.+Purchases at cost
c.-Ending inventory at cost
d.=Cost of good sold
Accountants will also include freight-in, as
Generally Accepted Accounting Principles requires
that this expense directly related to bringing
the merchandise available to sell be included.
Cash discounts are often also reflected as a
separate line item in the Cost of Goods section
of the financial statement as a reduction in purchases.
This is particularly true for retailers who include
discounts when determining initial mark up. Generally
Accepted Accounting Principles for publicly held
companies requires that they be reflected as a
credit expense or other income as a line item
on the income statement. In smaller companies
cash discounts and incentives are immaterial and
their placement on the financial statement is
at the discretion of the owner. It is important
that whatever is included be consistent over time.
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3. |
Gross
Profit- Net Sales minus Cost of Goods Sold. This
is the money that is available to pay other expenses,
bills, salaries, taxes and profits. |
4. |
Total
Operating expenses- A list of all your expenses-
occupancy, salaries, selling, general and administrative
expenses. A dividend or distribution that the owner
takes is not included in operating expenses. |
| 5. |
Net
Profit/(Loss)- Gross Profit minus operating expenses.
This is what is available for dividends, debt reduction,
or dollars to reinvest in the business. |
Sometimes financial statements will calculate Cost of
Goods Sold strictly as purchases for the period. It is
not quite that simple. Cost of Goods Sold is based on
goods available for sale during the period that is being
reported. Goods available for sale includes beginning
inventory as well as merchandise purchased during the
period reviewed. Simply stating purchases instead of an
accurate Cost of Goods Sold calculation does not take
into account beginning and ending inventory. For example,
merchandise theft impacts profits by raising Cost of Goods
Sold. The merchant pays for goods whether they are stolen
or given away. This is reflected in the difference of
beginning and ending inventory and the accurate reflection
of these transactions would boost the Costs of Goods Sold.
Showing only purchases as Cost of Goods Sold distorts
the profit and would result in decisions, like income
taxes to pay on a less accurate measurement.
How inventory is valued with the different acceptable
methods, like LIFO, FIFO, or Average Cost can have a direct
impact on your financial statement. (We will examine
this in greater detail in our November issue)
The accuracy of your financial statement’s Cost
of Goods Sold should be gauged each time you review it
by examining the related percentages in comparison to
prior periods and your knowledge and experience. Reflecting
Cost of Goods Sold accurately on a financial statement
is critical to its overall accuracy.
The first litmus test on the accuracy of a financial statement
is the Cost of Goods Sold. Its accuracy provides the level
of confidence in the exactness of the overall bottom line.
Here is a short list that can go wrong:
Inventory
Valuation
Cut off procedures for purchases to collect all receiving
within a given period
Omission of purchases awaiting invoices from vendors
Returns of merchandise to vendors or from customers
not recorded or included.
Net sales not recorded due to different procedures like
lay-a-way and special orders.
Unrecorded transactions for transfers of merchandise
Unrecorded invoices for merchandise
Overages, Shortages, or theft unrecorded
Promotional sales not recorded when sold
Gift certificates, payments in advance, or credit not
posted or not recorded correctly.
Damaged merchandise not reflected
Sales tax included inaccurately.
This November we will be taking a look at inventory valuation
in greater detail. The timing of this information comes
at a critical time in management’s decisions to
use correct valuation decisions for year-end statements
that could benefit tax situations.
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