Understanding the Cost of Goods Sold for Amazon
Estimated reading time: 6 minutes 30 seconds.
Part of running a successful Amazon ecommerce business is making sure you always keep an eye on your margins.
This includes more than just knowing how much Amazon deposits into your account.
You also need to know what your actual gross margins are each month so you can track trends, plan for growth, and spot potential problems.
The key to calculating your true monthly gross profit and keeping an accurate set of books is understanding your costs of goods sold.
What is the Cost of Goods Sold?
The cost of goods sold (COGS) is an accounting principle whereby you match up the cost of a product (and potentially also the cost of getting the product to market), with the sale of that product.
This gives you an accurate picture of what your true revenues, gross margins, and profitability is for a given month.
Accounting for COGS allows you to better manage your inventory by treating your product inventory as an asset on your books until you sell the product.
When you sell an item, its cost is deducted from the value of your asset (inventory). It is then applied against the revenue from the sale, so you can calculate gross profit.
The costs of goods sold includes the cost of the product and can optionally include all the costs of getting a product to market.
This could include:
- Procurement costs
- Production costs
- Taxes and duties
- Listing fees
- Inventory storage fees and costs
If you are fully loading your product cost with all of the additional expenses to bring the product to market (such as freight or duty) then you must ensure that you add those costs to the inventory asset balance. That way as you expense the COGS, it will be reducing the inventory asset the correct amount.
How Do You Do Cost of Goods Sold Accounting?
Let’s look at an example:
- Imagine you sell t-shirts.
- Each t-shirt costs you $10.
- In January you buy 1,000 t-shirts.
- You also know that each month you will sell 200 t-shirts at $20.
You could say that you had a $10,000 expense in January ($10 x 1,000 shirts) and revenues of $4,000 ($20 x 200 shirts).
That would give you a loss of $6,000 for the first month and then a gross profit of $4,000 for the next four months. But, this isn’t accurate.
It looks like you had one horrible month followed by four excellent months, and it distorts your gross profitability and margins.
When you use the COGS principle you would show an asset of $10,000 on your books in January. That asset would be reduced by $2,000 ($10 x 200 shirts sold). That $2,000 is your expense. Your revenue is still $4,000. But, instead of showing a loss, using COGS you see that you really had a gross profit of $2,000 ($4,000 revenue - $2,000 cost of the t-shirts).
COGS matches up the cost of the goods sold with the revenue for the products when they are sold.
In this t-shirt example, you can see that your business has steady profits, not one bad month followed by four great months.
COGS is an expense. But, more importantly, it is a system for making sure you are accurately capturing the expenses for each product that you sell. It allows you to understand your gross margins and how profitable your business truly is.
Let’s look at a slightly more complicated example:
We’ll use the same t-shirt business example, but this time let’s include the cost of freight in our product cost.
- Let’s imagine that the 1000 t-shirt shipment comes from overseas by airfreight and the cost is $1,000.
- We have had to pay an extra $1 per t-shirt to bring the products to market.
We can expense that $1,000 in the month where we airfreight the goods, or we can add the $1,000 to our inventory asset (that’s called capitalizing it).
If we expense it, it will make our profitability look worse that month, and better in each of the next four months. Again this distorts our view of our profitability and gross margins.
An approach some businesses will take is to capitalize the freight, so they record inventory as $11,000 instead of $10,000 and then use a product cost of $11 (being $10 for the product and $1 for the freight). That way it will more evenly spread the freight cost over the corresponding sales (and revenue).
This can make your cost price tracking more complicated (many businesses will use inventory management tools for this) but will give you a clearer, more accurate picture of your gross profits and margins.
How Do You Calculate the Cost of Goods Sold on Amazon?
A2X can calculate your COGS for you.
If you do not have access to A2X, you can calculate COGS manually for your Amazon inventory. How?
- Enter your inventory as an asset into your accounting software.
- Manually track your other costs (such as freight and duty).
- Match the costs you have entered to the sale of each product.
- Download the sales reports from Amazon, split them by month and calculate units sold x costs you calculated.
To get the most accurate financial picture of your business, it is best practice to match the COGS with the sale of each product, and then expense it to the correct month. This involves breaking down individual transactions.
You will need to do a little reverse engineering, taking the deposit you were sent from Amazon, and looking at all the associated orders with that deposit and within the same month. You can download this data from Amazon in a spreadsheet with relevant dates and SKUs laid out, which is helpful, but that’s where the help ends with COGS.
By using A2X to do this for you, you’ll save yourself hours of manual calculations and headaches trying to split orders by month yourself.
How Does COGS Work in A2X?
A2X software connects with your Amazon account and automatically downloads all of the relevant sales data.
You tell A2X what costs you wish to use and the software will calculate the COGS as it applies to each Amazon deposit (split into the correct months).
Instead of manually matching costs to sales, A2X has a feature that will import your Amazon data, match sales to costs, and then expense the COGS into the correct month in your accounting system.
To make the entire process even better for your accounting, the source data and audit trail for the COGS calculations is attached in the accounting system.
This way, if you need to reproduce the cost of goods calculations or support them with evidence, (for example: if you were audited in the future), the data is stored against the corresponding transactions creating an easy to understand audit trail.
Instead of just guessing at what your business’s monthly financial performance, you can get an accurate picture every month, without having to spend hours sorting through data and entering transactions into your software.
Because it is automated, A2X also greatly reduces the possibility of data entry errors and creates a reliable record of the transactions in your accounting system.
Also on the blog:
- 6 Common Accounting Mistakes that FBA Sellers Make
- Amazon Pay Accounting and Reconciliation with A2X
- Intelligent Automation for the Amazon Seller
- Why More Sellers are Diversifying Away from Amazon
- When to Hire an Accountant for Your Amazon Business
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