Sales cost is the cost spent on producing goods or service provided in a particular period by a company i.e. material, labour and indirect costs. It consists of the total cost of direct raw material used to produce goods, labour cost spent on producing goods, and all other types of direct sales cost associated with the production of goods.
However, in the case of service provided, sales cost consists of salaries or costs of employees and all other types of attribute costs associated with the production.
Indirect expenses, such as marketing cost and distribution cost, are not included in the sales cost. The indirect costs appear only on the income statement and are deducted from the total sales revenue for the calculation of gross profit or gross margin.
A sales cost does not include overhead costs, and it consists of more variable costs and less operational costs. However, fixed cost such as labour cost is included in the sales cost. But, generally, it entirely consists of variable costs only.
Because inventory can be revalued, the sales cost in a particular period is an amalgamation of two methods of allocating the inventory’s cost. For example, first-in, first-out (FIFO) and any reassessment of inventory, and also average cost.
It is also affected by the methods of allocation of overhead costs to a particular product. Sales cost can be calculated in various ways.
How to calculate the Sales Cost?
The sales cost is an important financial metric for all types of businesses as it includes all the cost involved in producing and selling a product.
The job of business managers is to monitor and analyze sale cost to make sure that the expenses do not go beyond the estimated budget and, hence, the company is making a profit. However, to get an accurate figure for sales cost.
It must include all purchase and production cost and all other indirect costs. Sales cost is also known as the cost of goods sold (COGS).
Different categories in COGS production:
- The material used in manufacturing a product.
- Direct labour cost used to produce a product.
- Indirect material used to support the production process.
- Production facilities’ cost.
- Indirect labour required for the manufacturing process.
Calculation of cost of material
A material cost for a retailer is the cost of purchasing product that he intends to resell to make a profit. On the other hand, the material cost for a manufacturer is the cost of material which includes raw material and parts used to built final products. The formula used to determine both types of material cost is similar.
Material costs= Purchases + Beginning inventory -Discount of suppliers – suppliers’ returns – ending inventory.
Let us understand sales cost with the help of a working example of John’s purse shop
Beginning inventory = $90,000
Plus Purchases = $60,000
Less Suppliers’ discounts = $2000
Less returns to suppliers = $1000
Less ending inventory = $50,000
Total sales cost = $ 97,000
The method to calculate sales cost for a manufacturer is slightly different than the calculations mentioned above. The following is a working example of sales cost for a manufacturer.
Beginning inventory for parts and raw materials = $90,000
Plus purchases for parts and raw materials = $60,000
Less suppliers’ discounts = $2000
Less returns to suppliers = $1000
Less ending inventory of materials = $50,000
Total cost of material = $97,000
Both above examples don’t include any direct labor or any other indirect costs.
Followings are the three methods used by accountants to determine the value of inventory.
1) First in First out
In this method, it is assumed that the first manufactured product will be sold first. The net income tends to be increasing over the period during a period of rising prices.
2) Last in First out
In this method, it is assumed that the last manufactured goods are sold first. The net income tends to be decreasing throughout rising prices.
3) Average cost method
this method includes the average purchase prices of all material and goods in stock without concerning the date of its purchase.
All direct labour costs used in the manufacturing process of products should be included in the sales costs.
In addition to direct labour costs, all indirect labour costs used to support manufacturing process is also included in the total sales cost. Followings are some examples of indirect labour costs.
- Wages for quality-assurance personnel.
- Salaries of production supervisors.
- Shipping and receiving employees.
- Warehouse administrative staff.
- Maintenance mechanics.
- Janitors who clean the production areas.
Indirect costs are all those expenses which are not directly part of the acquisition or production of products. However, these costs are important for the calculation of total sales costs. Followings are the different examples of indirect costs.
- Depreciation of machines and building.
- Utilities, rent, and insurance of the warehouse and all other manufacturing facilities.
- Parts of equipment repairs and maintenance.
- Lease payments on transportation vehicles/ equipment and production.
- Costs of small tools.
- Supplies used to support production machines and equipment.
- Property taxes on storage facilities and manufacturing.
Business owners need to know about the profitability of their business so that they can determine all non-performing areas and work on to improve them. The calculation of sales cost is an essential tool which provides data on the efficiency of the production process of a company.
Knowing goods and products sold gives information to the business manager about which product is more profitable than the others. This information can help the business owner to take a decision which product should be promoted and which unprofitable products should be eliminated from the production.