What is Cost of Sales and How is it Calculated?

Cost of sales is a key performance indicator (KPI) used to measure the financial health of a business. Also known as cost of products sold or cost of goods sold, it reveals the total direct cost a business incurs to produce its products or services. While retailers rely on this KPI extensively in their operations, the fact is that all businesses, regardless of what they sell, should closely monitor and track their cost of sales.

What is Cost of Sales?

Cost of Sales Explained

The purpose of calculating cost of sales is to provide insight into how much money a business spends to produce its products or services.

All businesses produce products or services. Even if a business doesn’t directly manufacture its products itself, it still “produces” them by purchasing them from a supplier. The amount of money a business spends to produce its products or services are considered cost of sales.

Business owners can better optimize their operations by monitoring and tracking their cost of sales. If a business’s cost of sales is too high, it will lower its profit margins for the products or services that it sells.

Steps to Calculating Cost of Sales

To calculate cost of sales, you must add up all direct expenses associated with the production of your business’s products or services. Only direct expenses are factored into this financial KPI. Cost of sales doesn’t take into account indirect expenses like marketing, advertising and distribution.

When calculating cost of sales, add up all direct expenses associated with the production of your business’s products or services. Examples of direct expenses include the following:

• Labor
• Materials
• Salaries (for businesses that sell a service)

Calculating Gross Margins From Cost of Sales

You can then use your cost of sales to determine your gross margins for the products or services that your business sold. To calculate gross margin, subtract your cost of sales from your revenue for the given period. If your revenue last month was $60,000 and your cost was $15,000, your business’s gross margins were $45,000.

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