The Complete COGS Overview for Consumer Product Brands
Sonder Accounting contributed to the COGS Guide in FoodBevy's Guide to Starting a Food or Beverage Business. The article you are reading is the complete COGS chapter with our contributions to the FoodBevy content. You can find the whole guide right here for incredibly detailed information on topics from marketing to maufacturing in a food/bev CPG business.
COGS – or Cost of Goods Sold – isn’t just a line item on your financial statement. It’s the heartbeat of your product pricing, the key to understanding your profitability, and a vital measure of your business’s health.
Let’s break down the components of COGS, show you how to calculate it, and offer strategies to manage it effectively.
COGS are made up of three major categories:
Ingredients
Packaging
Production Cost
Only Include What Your Customers Value
Every decision you make around ingredient selection, certifications, and packaging should align with a problem you’re solving for your customer – and that they will pay for. If your customers value organic ingredients, then sourcing certified organic inputs makes sense. If they’re eco-conscious, investing in sustainable packaging can justify a higher price point.
A brand targeting health-conscious consumers might choose non-GMO ingredients and BPA-free packaging. These choices increase COGS but align with customer values, making them willing to pay a premium.
Ingredient Cost
First things first: list every ingredient and material required to produce your product. This includes everything from the main ingredients to minor additives. You’ll also need to think about where these materials come from. Finding reliable suppliers is crucial; your production depends on their consistency and quality.
For a granola bar, your list might include oats, honey, nuts, dried fruits, and any flavorings or preservatives.
You’ll want to know exactly how much it costs to produce each single unit of product.
To calculate the cost of ingredients, start by measuring how much of each ingredient goes into a single batch. Then, determine how much final product that batch yields. Here’s how:
List Ingredients and Quantities: Break down the amount of each ingredient used per batch.
Example: For a batch of granola bars, you might use 10 kg of oats, 5 kg of honey, 3 kg of nuts, and 2 kg of dried fruits.
Determine Ingredient Costs: Find the cost per unit for each ingredient.
Example: If oats cost $2 per kg, honey $4 per kg, nuts $6 per kg, and dried fruits $5 per kg, your ingredient costs are calculated accordingly.
Calculate Total Batch Cost: Multiply the quantity of each ingredient by its cost and sum them up.
Example:
Oats: 10 kg x $2 = $20
Honey: 5 kg x $4 = $20
Nuts: 3 kg x $6 = $18
Dried fruits: 2 kg x $5 = $10
Total Batch Cost: $20 + $20 + $18 + $10 = $68
Yield of Final Product: Determine how much final product the batch yields.
Example: If the batch yields 200 granola bars, you then calculate the cost per unit.
Calculate Cost Per Unit: Divide the total batch cost by the number of units produced.
Example: $68 / 200 bars = $0.34 per granola bar.
Packaging Cost
Packaging isn’t just about containing your product. It’s about protecting it, promoting it, and ensuring it reaches the customer in perfect condition. The cost of packaging can vary widely depending on the materials and design you choose.
Packaging your product may include many layers, so make sure you include each of these in your cost.
Example:
For our energy bar, they require three packaging levels:
Individual Wrapper – $0.10 per bar
Inner Case (paperboard packaging that held 12 bars) – $0.15 per bar
Master Case (Cardboard that held 8 inner cases) – $0.03 per bar
Total: $0.28 per bar
Production Cost
If you’re shelf manufacturing, your production cost includes everyone involved in producing your product. This isn’t just the people on the production line but also those involved in quality control, supervision, and even the temporary workers during peak times.
If you’re working with a co-manufacturer, your production cost is usually charged as a “tolling fee”, which wraps up their entire operating cost into a unit price.
Self- Manufacturing Costs
Labor
Labor costs include all wages paid to employees involved in production. This can be broken down into:
Direct Labor: The workers who are physically making the product.
Example: If you have 2 workers each earning $15 per hour and it takes 1 hour to produce a batch, the direct labor cost is:
2 workers x $15/hour x 1 hour = $30 per batch
Indirect Labor: Supervisors, quality control staff, and other support personnel.
Example: If a supervisor oversees multiple batches and is paid $20 per hour, calculate the portion of their time spent on this batch.
Production Overhead
These are the fixed and variable costs associated with running your production facility. They include:
Utilities: Electricity, water, gas.
Example: If your monthly electricity bill is $1,000 and you produce 100 batches a month, the electricity cost per batch is:
$1,000 / 50 = $10
Rent: The cost of leasing your manufacturing space.
Example: If your rent is $5,000 per month and you produce 100 batches, the rent cost per batch is:
$5,000 / 100 = $50
Equipment Depreciation: The cost of equipment spread over its useful life.
Example: If a machine costs $10,000 and has a 5-year lifespan, its monthly depreciation cost is:
$10,000 / (5 years x 12 months) = $167
Depreciation cost per batch: $167 / 100 = $1.67
Maintenance and Repairs: Ongoing costs to keep equipment running smoothly.
Example: If monthly maintenance is $300 and you produce 100 batches, the cost per batch is:
$300 / 100 = $3
Waste and Spoilage: Raw materials that are wasted or spoil during production.
Example: If 5% of your raw materials are typically wasted, factor this into your material costs.
Total Production Cost Calculation
To find the total production cost per unit, combine all these costs:
Direct Labor: $30
Indirect Labor: (calculated portion, e.g., $5)
Utilities: $10
Rent: $50
Equipment Depreciation: $1.67
Maintenance and Repairs: $3
Waste and Spoilage: (additional cost added to material costs)
Total Production Cost for Batch: Sum of all the above costs:
$30 + $5 + $10 + $50 + $1.67 + $3 = $99.67
Cost Per Unit: Total Production Cost / Number of Units Produced
Example: If the total production cost for the batch is $99.67 and you produce 200 units, the cost per unit is:
$99.67 / 200 = $0.50 per unit
Co-Manufacturing Costs
When working with a co-manufacturer, also known as a toll manufacturer, you pay a fee for the use of their facilities, equipment, and labor to produce your product. This fee is known as the tolling cost and can vary depending on several factors:
Volume: Higher production volumes often result in lower per-unit tolling costs due to economies of scale.
Complexity: More complex production processes may incur higher tolling costs.
Customization: Custom formulations or packaging requirements can increase costs.
As an example, your tolling fee may be $0.60 for this product.
Comparing Self-Manufacturing and Co-Manufacturing Costs
In our example, we’re able to calculate the cost for both manufacturing options.
Self-Manufacturing Cost
Ingredients: $0.28
Packaging: $0.28
Production: $0.50
Total Cost: $0.96 per bar
Co-Manufacturing Cost
Ingredients: $0.28
Packaging: $0.28
Production: $0.60
Total Cost: $1.06 per bar
In this example, we can see that Self-Manufacturing is a little bit less expensive than working with a co-manufacturer, but cost isn’t everything.
Running your own manufacturing facility is like running a separate business, with its own complexities and headaches. Make the decision based on your overall business vision and how you want to spend your time.
Economies of Scale
As your production volume increases, your per-unit costs can decrease, but only to a limit. This is due to economies of scale, where bulk purchasing and efficient production processes reduce costs.
In my experience, discount levels occur at the following levels:
Case
Pallet
Truckload
Discounts usually max out at truck load levels. Don’t operate at a high COGS level, hoping that it’ll come down to something reasonable at volume. Make sure your costs are low enough to give you a good margin now, so that you can survive long enough to take advantage of the discounts later.
Adjusting to Market Cost Changes
The market is dynamic, and prices can change quickly. Stay agile by continuously monitoring costs and exploring ways to reduce them. This might include renegotiating contracts or finding alternative suppliers.
Review your COGS inputs quarterly, or whenever you make a major change
Continuously look for new suppliers to ensure you have the best costs.
Local Suppliers Reduce Cost
For TeaSquares, I found a great Almond supplier based in Washington state. The problem was that our production facility was in Chicago. The actual product cost was reasonable, but when I calculated shipping it added an additional 40% to the product cost.
Instead, I found a new local supplier that not only had the same product cost, but also delivered to our facility for free.
When possible, find good suppliers who are close to your manufacturing facility to reduce inbound shipping costs.
Impact of COGS on Financial Reporting
The way you track and manage your COGS inside your bookkeeping significantly influences several key financial metrics, including gross profit, net income, and inventory valuation on the balance sheet. You can dive deeper into the Accounting Chapter, but we couldn’t skip out on tying this together for you.
Gross Profit and Inventory Valuation
Gross profit is calculated by subtracting COGS from total revenue. Therefore, any miscalculation in COGS can lead to inaccurate gross profit figures in the financials you use to guide your business, pitch for financing, pay taxes, and more.
Often, new brands overstate their COGS within their bookkeeping records by incorrectly categorizing all production and inventory purchases as COGS expenses immediately. This reduces the calculated gross and net profits, potentially making a profitable business appear less successful or even unprofitable.
Incorrectly booking all inventory purchases directly to COGS can also severely distort inventory valuation. This practice can lead to an undervaluation of assets on the balance sheet, affecting liquidity ratios and the perceived financial stability of the company. Accurate inventory valuation is vital for reflecting the true financial position and operational efficiency of the business.
Proper Accounting Practices
A properly set-up accounting system includes the following activities for COGS & inventory:
Record Purchases to Inventory: All ingredient and material purchases should initially be booked to an inventory asset account.
Expensing Upon Sale: Costs should only be transferred from inventory to COGS as the related products are sold. This method ensures that expenses are matched with revenues, providing a clearer picture of profitability.
Periodic Inventory Checks: Regular inventory audits and reconciliations help ensure that inventory records accurately reflect actual stock levels and that any discrepancies are promptly addressed.
By implementing these practices, your business can achieve more accurate financial reporting, providing clearer insights into profitability, financial health, and operational efficiency. This improved accuracy not only aids in better decision-making but also builds trust with stakeholders and complies with IRS guidelines on inventory reporting.
Sonder Accounting supports emerging food, beverage, and wellness brands as they scale from pre-revenue to $20M annually. Join over 100 founders who have chosen Sonder for comprehensive financial management, including:
Monthly Bookkeeping and Annual Income Tax services
Fractional CFO Support and Proforma Development
Sales Tax Setup, Margin Analysis and more custom projects.
Schedule a discovery call to learn how we can support your business.
If you enjoyed this chapter, we highly recommend checking out the complete FoodBevy Guide to Starting a Food or Beverage Business.
Comments