By Adam Hoeksema
Cost of Goods Sold, also known as COGS, is one of the most difficult, yet important elements of your business to understand. The basic definition of cost of goods sold is as follows:
“The direct costs attributable to the production of the goods sold by a company. This amount includes the cost of the materials used in creating the good along with the direct labor costs used to produce the good.”
There is often much confusion between Cost of Goods Sold and Cost of Sales, this article explains COGS for a service business.
Today, I want to focus on 3 simple ways you can reduce your COGS which will translate directly to your bottom line.
1. Buy in Larger Quantities – When you buy in larger quantities you will often be able to take advantage of quantity discounts. You may also benefit from shipping discounts. It is much, much cheaper per unit to ship a truckload full of product than it is to ship a pallet full of product. This is a no brainer, but some entrepreneurs never even ask their supplier what sort of discounts they could benefit from if they were to purchase in larger quantities.
2. Automate – In a world where we need jobs, this might not be a popular answer with the governments of the world, but for each job you can replace with a machine, your cost of goods sold will decrease drastically. Machines don’t form unions, they don’t go on strike, they don’t need health insurance, and they get to work on time. If you don’t automate in the areas that you can, your competitors will, and you will ultimately go out of business because you simply won’t be able to compete with their prices.
3. Lock in Long Term Pricing for Raw Materials – This is a bit of a risk, but for some companies this strategy really pays off. For example, Southwest Airlines locked in pricing for jet fuel in a long term contract right before fuel prices spiked exponentially. This gave Southwest a huge advantage over their competitors. On the other hand, what if Southwest locked in the prices right before the price of fuel crashed? Their COGS would have been awful compared to the industry. If you think the price of a raw material that is core to your business is poised to increase, you may consider entering into a long term agreement with a supplier.
If you would like to play around with some numbers and project how your cost of goods sold would be impacted by various scenarios, then create a quick set of financial projections with ProjectionHub and we will walk you through the process of projecting cost of goods sold. Good luck!