The Role of COGS in Inventory Management

February 7, 2023


As a retail business, managing inventory and calculating COGS (cost of goods sold) is paramount to ensure the proper functioning of operations while also maximizing profits. Both are equally crucial in ensuring smooth business flow.

As a merchant, it’s essential to be aware of the number of units in stock and how much profit each product adds to your bottom line. Unfortunately, attempting to keep track of all this information with numerous spreadsheets can quickly become complicated and time-consuming. It's often difficult for merchants to accurately determine their true profits from day-to-day operations without expert help.

With the help of accounting software such as QuickBooks or Xero, COGS updates can be automated using PayTraQer - eliminating the additional cost of sourcing costly accountants and complicated analytical tools.

However, it's important that you understand how COGS is calculated and how it's directly related to inventory. This article will assist with the same.


What is COGS (Cost of Goods Sold)?

How is COGS related to Inventory Management?

How to Calculate Cost of Goods Sold For Your Inventory?

5 Ways to Improve Inventory Management by Minimizing COGS

Use multiple suppliers to procure material or finished products

Source materials at competitive prices to maximize budget and profitability

Strengthen negotiations with suppliers

Consider outsourcing manufacturing operations

Use automation to improve mundane and repetitive processes

What is COGS (Cost of Goods Sold)?

Cost Of Goods Sold (COGS), known also as Cost of Products Sold or Product Costs, is the sum a company spends on creating and delivering products to its customers. In a few words: it's what you pay for your goods.

COGS is the most substantial expense for any retail business. If your calculation of COGS is inaccurate, it can significantly reduce margins and harm taxable income; this will cause incorrect profit statements in turn. Moreover, an erroneous COGS has significant influence over important decisions like advertisement spending, inventory orders and retail pricing; ultimately leading to more flawed choices down the line.

Typically, the Cost of Goods Sold (COGS) accounts for a product's labor costs, materials expenses and overhead in addition to any estimated post-sale service charges. Manufacturing and storage prices are also included in this total.

When purchasing inventory, your product costs may include shipping fees for transporting goods from a supplier to your warehouse. To calculate COGS (cost of goods sold), you'll need to account for the cost of purchases, production materials, labor (if any is used), tariffs and taxes on imports/exports, inbound freight expenses like fuel surcharges or customs clearance fees, retail packaging prices as well as storage-related charges.

How is COGS related to Inventory Management?

Understanding the relationship between Cogs and Inventory Management is critical for any business. Cogs stands for Cost of Goods Sold which represents both the direct and indirect costs associated with producing and selling a product or service.

Inventory Management, on the other hand, is the practice of efficiently managing physical products or materials in stock. The two concepts work closely together since Cogs affects your inventory levels.

Cogs help you figure out exactly how much an item should cost when you sell it and also provides insights into deductions that can be made from your inventory depending on what products have been sold. This ultimately leads to better budgeting, forecasting and profitability goals. Ultimately, Cogs and Inventory Management are important tools used to help businesses track their financial performance over time.

How to Calculate Cost of Goods Sold For Your Inventory?

Retailers and manufacturers commonly rely on this COGS formula to accurately determine their costs:

Cost Of Goods Sold (COGS) = Beginning Inventory + Purchases - Ending Inventory


  • Beginning Inventory represents what is currently in-stock at the start of a month or period.

  • Purchases include any newly obtained or produced inventory.

  • Ending Inventory is what remains after all products have been sold at the end of the month.

Suppose that you are a denim producer and at the start of the month, had 200 units in stock. You paid $50 to manufacture each unit. Midway through the month, an additional 70 products were produced as well. By month's end, 150 pieces were sold leaving 80 items for inventory purposes alone.

Now let’s calculate COGS:

COGS = Beginning Inventory + Purchases - Ending Inventory.

Beginning Inventory = 200 units X $50 = $10,000

Purchases = 70 Units X $50 = $3,500

Ending Inventory = 150 Units X $50 = $7,500

COGS = $10,000 + $3,500 - $7,500 = $6,000.

So the total cost of goods sold for the month is $6,000.

5 Ways to Improve Inventory Management by Minimizing COGS

Use multiple suppliers to procure material or finished products

If your products are not too distinctive or unique, you have the luxury of choosing from a plethora of suppliers that offer similar items. To ensure you and your customers reap optimal benefits, evaluate different vendors' features, strengths and weaknesses before settling on one.

If you're looking to get the most out of your purchase, consider asking questions such as: Could I receive a more competitive rate? Can they provide faster delivery? Are there any additional discounts available?

To reduce your inventory costs, always look for the supplier with the most advantages. If you're able to place bulk orders, it's likely that you'll receive attractive discounts - particularly in regards to shipping as one large container of products is more cost-effective than a few small ones. Don't be afraid to ask your suppliers about any additional discounts available; this could help significantly lower your COGS!

Source materials at competitive prices to maximize budget and profitability

Cutting down on material costs is essential for any retail business. Nonetheless, it is vital to approach this process with caution and take into account all the necessary variables such as adapting modern technology, demand levels, and cost.

When ascertaining the worth of your product, it's essential to evaluate how much value customers place on its features. If you have a product which uses rare materials, for instance, this may involve higher input costs. However if consumers don't appreciate these special features then it could be preferable to use cheaper materials instead.

It's essential to keep in mind that you can always pick more affordable materials without compromising on quality. Making hasty and unthought-out moves when trying to cut back on your product expenses could only drive away potential customers.

Strengthen negotiations with suppliers

For your business to be prosperous, strong partnerships with providers and vendors are essential. Don't forget that you can negotiate the cost of goods sold to make sure you get the best deal! Developing a negotiation strategy is key to optimizing COGS, so take some time to devise one today.

Without a doubt, your suppliers would want to be just as lucrative as you are. Yet, it is imperative to not give them too much power and instead shrewdly play your hand in negotiations. If you can procure the finest cost for what you offer while paying out to vendors and associates at the least possible rate - it will have an incredible effect on profit margins.

To boost your profits and lower expenses, you must assess the necessity of inventory protection measures in addition to comprehending what customers may require. Doing so enables you to eliminate unnecessary costs and ultimately minimizes your COGS.

Consider outsourcing manufacturing operations

Outsourcing is not a contemporary practice – many global businesses have implemented it for decades. It involves transferring business processes to countries with lower labor and material costs, thus allowing organizations to reap substantial savings.

While outsourcing production overseas can be rewarding for your business, it's critical to recognize the potential drawbacks that may arise. Cultural differences and language barriers are just a few of the issues you'll come across when dealing with foreign suppliers. Moreover, quality control management must also be taken into consideration in order to ensure on-time delivery of top-notch manufacturing processes.

Once you determine a strategy that works best for your business, you will undoubtedly experience more lucrative profit margins.

Use automation to improve mundane and repetitive processes

Thanks to the appearance of technology in various aspects of retail and online businesses, you can now modify them to automate tasks that require minimal human input. Automation not only gives you more cost-savings in terms of employee expenses, but also provides a competitive edge over rivals when it comes to operations management.

By using automation, you can drastically reduce expenses and enhance the accuracy, speed of completing tasks, developing products & services as well as providing support. It also helps to minimize human mistakes for optimum profitability in your organization.