There are many tools and techniques that business owners and manufacturers use to determine profitability of a company. One of those techniques is calculation of the cost of goods manufactured (COGM). This formula allows the manufacturers to get the estimated amount of overall cost of production to understand how this estimated amount is going to impact their balance sheet and income statement.
But what is the purpose of the statement of cost of goods manufactured? What are the examples of the cost of goods manufactured and how to calculate the cost? We will cover these questions in this article.
What cost of goods manufactured means?
The cost of goods manufactured is the amount that a company spends on the production of goods that are to be sold in the market in a specific period of time. The calculation involves every expense that the company incurs in the manufacturing process, including factory overheads, material costs, labor expenses, and cost of direct materials. Let’s check out an example for a clearer understanding
A furniture manufacturer, ABC, has an inventory of $100,000 in the form of finished goods at the starting of the period. During the given time, the manufacturer has spent $50,000 on purchasing materials for table and chairs, $125,000 paid in labor costs, and for the rental expenses, it has spent $65,000.
After calculating the production cost, the managers of ABC determined that the cost of remaining goods in the inventory was around $75,000 during the period.
Therefore, the COGM can be calculated by the formula:
COGM = Work in progress (inventory) + Total cost of manufacturing – Ending good/inventory
that would be $265,000 after calculating – ($100,000 + $50,000 + $125,000, + $65,000 – $75,000).
This means that the manufacturer has $265,000 worth of the furniture goods and will move the expenses records from the account of work in progress to the finished goods account after the period.
Why is the cost of goods manufactured important?
The COGM is important when manufacturers and business owners want to know the production cost whether the total cost of production would be too low or too high at the end of the given period. To maximize the overall profitability, companies tend to make adjustments in the expenses of finished goods they manufacture.
Other than the estimation of cost of production, the benefits that of COGM include:
- The COGM allows a company to adjust its pricing strategy for the unfinished and finished goods
- Enables companies to plan the volume of the resources and inventory for the next period
- Provides a rationale comparison of the cost of manufacturing inventory for year-on-year basis
- Helps in the settlement of liabilities and financial records
- Determine the easiest way to record and classify expenses
The COGM is important for manufacturers who regularly produce finished goods to sell. Moreover, it helps identify the cost that impacts the company’s net profit at the end of the period.
How COGM is related to COGS?
If you want to know about the cost of goods manufactured, then you must look at the section of the cost of goods sold in the income statement, where the cost of goods inventory is the key source to calculate the cost of goods sold.
As far as the cost of goods sold is concerned, it is the cost that a company spends on producing goods to sell. The COGM shows the expenses against the goods or inventory (finished or unfinished) and services. Once the COGM has been calculated the total cost of production would be recorded in the final inventory section in the balance statement. This final inventory records the number of goods and services that are ready to be sold.
With all the pieces of the puzzle in place, we can calculate the COGS, the cost of goods sold.