Navigating the complexities of Cost of Goods Sold (COGS) can be a daunting task for Amazon sellers and ecommerce brand owners. But understanding this critical component of your business is essential for several key reasons. In this blog, we’ll break down why COGS matters, how to define and calculate it, and the importance of inventory adjustments.
Why Accurate COGS Matters
1. Confidence in Tax Filing: Having precise inventory and COGS figures allows you to confidently file your taxes correctly without the fear of audits or unintentional underreporting. It’s the foundation of your financial integrity and stress-free tax filings.
2. Driving Business Results: Accurate COGS empowers you to leverage your financial data for informed decision-making. You’ll be able to steer your business toward improved cash flow and profitability by making data-driven choices.
3. Preparing for Exit: If you ever plan to sell your ecommerce brand, potential investors will scrutinize your COGS and inventory accounting. In an increasingly competitive market, having defendable, accurate financial records boosts investor confidence and enhances company valuation. It’s also often the most challenging part of due diligence and can significantly impact the sale price.
Let’s first start by understanding the difference between the COGS section and COGS line item on your P&L statement. The P&L section for COGS encompasses all expenses related to getting your product from the factory to the customer. However, the COGS line item is just the cost to bring your product from the factory to the warehouse. In the context of this article, we are focusing on the COGS line item. It encompasses various expenses, including:
1. Factory Invoice: This is the base cost of goods.
2. Duties: Any customs duties paid during import.
3. Ocean Freight: Shipping costs from the supplier’s location.
4. Tariffs: Import tariffs, if applicable.
5. Additional Expenses: Any other costs directly related to the product’s journey.
Here’s a simple step-by-step approach:
1. Inventory Asset Account: Record purchases for goods, duties, freight, tariffs, and any expense related to getting your product from the factory to the warehouse in an inventory asset account on the balance sheet until the unit is sold.
2. Calculate the Per-Unit Factory Cost: In a spreadsheet, list all your SKUs, purchased quantities, total factory invoices, and calculate the per-unit factory cost.
3. Loading Additional Costs: In the same spreadsheet, distribute duties, ocean freight, and tariffs across each SKU. Apply a uniform percentage for simplicity, especially if your products are similar in size.
4. Calculate the Per-Unit Landed Cost: Add the per-unit costs from step 3 to the per-unit factory cost calculated in step 2. This total represents your Landed COGS per unit.
5. Monthly Calculation: Determine the number of units sold and shipped in a month and multiply this by the landed COGS value per unit calculated in step 4. This amount is deducted from the inventory asset account on your balance sheet and moved to the COGS line item on your P&L statement. This method provides an accrual-based representation of your business’ performance.
The Importance of Inventory Adjustments
Inventory adjustments ensure that the value of the inventory on your balance sheet aligns with the actual inventory in your possession. This process helps verify the estimates made for each unit’s landed COGS. Regular adjustments, ideally quarterly, are recommended. More frequent adjustments may be necessary for larger sellers or in preparation for due diligence. Stay tuned for our next blog post on inventory adjustments and reconciliation, which will delve deeper into ensuring the accuracy of your financial records.
A Note on FIFO
While FIFO (First In, First Out) is a standard accounting principle and common inventory method, it’s often impractical for ecommerce businesses due to the complexity of inventory management across various platforms. Instead of getting bogged down by strict FIFO adherence, focus on the method outlined above, which offers excellent accuracy and simplifies the process, making it more scalable for ecommerce operations.
Mastering the calculation of landed cost of goods sold is essential for ecommerce success. By following these guidelines, you can ensure accurate financial records, make informed decisions, optimize profitability, and prepare your business for a future exit strategy. If you find this process overwhelming, consider seeking expert help from professionals experienced in ecommerce accounting, like Seller Accountant. Accurate accounting empowers your business to thrive and make a meaningful impact on your life and community, aligning with the entrepreneurial spirit that drives change in the world.