Calculating the Cost of Goods Manufactured is a good way to get an overview of production costs and how they relate to the bottom line of your business. It allows management to identify cash drains, to adjust prices, and to track the development of the business.
You can also listen to this article:
What is the Cost of Goods Manufactured?
The Cost of Goods Manufactured (COGM) is an accounting term that signifies the total cost of manufacturing products and transferring them into finished goods inventory during a set accounting period.
That means COGM only accounts for finished products that have either already been sold or are ready to be sold. As such, it is a good tool to get the big picture of production costs and gauge the profitability of a business.
Why is the Cost of Goods Manufactured important?
As said above, COGM is a good way to get a general idea of your production costs and how they correspond to the profitability of the business. Knowing the COGM allows you to increase the bottom line by making adjustments where necessary.
Furthermore, knowing the COGM helps companies to:
– better manage their inventory
– keep better financial records
– develop better pricing strategies
– track business development.
These benefits make COGM an important KPI to track in every manufacturing company.
Read more about Important Manufacturing KPIs.
Cost of Goods Manufactured vs. Total Manufacturing Cost
The Cost of Goods Manufactured and the Total Manufacturing Cost are similar and related terms. However, if the Total Manufacturing Cost is comprised of the direct material costs, direct labor costs, and the firm overhead costs, the Cost of Goods Manufactured also accounts for the change in Work-in-Process Inventory.
The Total Manufacturing Cost is, however, a part of the Cost of Goods Manufactured.
Read more about How to Calculate Total Manufacturing Cost.
How to calculate the Cost of Goods Manufactured?
COGM is comprised of all costs related to making the finished products, including:
– Direct materials used. You can calculate the direct material costs by taking the beginning raw materials inventory, adding the cost of the raw materials purchased, and subtracting the ending raw materials inventory.
– Direct labor used. This means only the salaries of the employees directly dealing with production activities, i.e. the shop floor workers.
– Manufacturing overhead assigned to the production of the goods. This includes indirect materials that are used in production but are not necessarily part of the product (e.g. glue, sandpaper, lubricant, etc.); indirect labor such as supervision, quality control, materials management, and others that are not directly responsible for the production of goods but without whom production would not happen; depreciation of the premises and of the production equipment; rent or property taxes; and insurance.
All of the abovementioned costs make up the Total Manufacturing Cost.
The COGM also accounts for the Beginning WIP Inventory, i.e. the cost of the goods that are unfinished in the production process during the accounting period.
In order to calculate COGM, just add the Beginning WIP Inventory to the Total Manufacturing Cost, and subtract the Ending WIP Inventory. This will give you the total cost of the goods that were finished during the specified period.
Read more about Work in Process Inventory Accounting.
At the start of a quarter, a furniture manufacturer has $12,000 worth of furniture in the making. This is the Beginning WIP Inventory.
Beginning WIP Inventory = $12,000
Furthermore, the company has $8,000 worth of raw materials in stock, waiting to be made into furniture. Within the quarter, the raw material inventory is replenished with $5,000 worth of stock altogether. At the end of the period, $3,000 worth of stock remains as raw materials. Using these figures, we can calculate the Direct Materials used.
Direct Materials = $8,000 + $5,000 – $3,000 = $10,000
The company employs eight shop floor workers that are directly responsible for the execution of production processes. Four of them have seniority or special skills and make $2,600 a month, the other four make $2,200 a month. The sum of their three-month salaries (as we decided that the accounting period for the calculations is a quarter, i.e. three months) is the Direct Labor Costs.
Direct Labor = [($2,600 x 4) + ($2,200 x 4)] x 3 = ($10,400 + $8,800) x 3 = $19,200 x 3 = $57,600
The Manufacturing Overhead is $28,600 altogether, comprising indirect labor costs for maintenance (wages $9,000 in a quarter) and warehouse (wages $12,000 in a quarter), additional materials such as glue and sandpaper ($800), rent ($6,000 per quarter), insurance ($200 per quarter), and an equipment depreciation of $2,400 a year, i.e. $600 per quarter.
Manufacturing Overhead = $28,600
So, the Total Manufacturing Cost for the quarter is the sum of the direct material and labor costs, plus manufacturing overhead.
Total Manufacturing Cost = $10,000 + $57,600 + $28,600 = $96,200
At the end of the quarter, $11,000 worth of furniture was still in the production process. This is the Ending WIP Inventory.
Ending WIP Inventory = $11,000
And finally, we get the Cost of Goods Manufactured by adding the Beginning WIP Inventory to the Total Manufacturing Cost and subtracting the Ending WIP Inventory.
COGM = $12,000 + 96,200 – $11,000 = $97,200
According to these basic calculations, the quarterly COGM of the furniture company is 97,200 dollars.
Cost of Goods Manufactured vs. Cost of Goods Sold
The COGM and the COGS are also very similar terms, but they are not to be confused with each other.
While the Cost of Goods Manufactured accounts for both those finished products that have already been sold and those that remain in inventory waiting to be sold, the Cost of Goods Sold includes only the costs of making the products that have been sold during the accounting period.
However, COGM is part of the COGS formula in periodic inventory accounting.
According to the previous example, if the company had a $10,000 beginning and a $20,000 ending finished goods inventory for the quarter, the COGS was:
COGS = $10,000 + $97,200 – $20,000 = $87,200
The COGM and the COGS can differ for various reasons, such as:
– more items were produced than sold during the accounting period (i.e. some items that were produced remain in stock, waiting to be sold).
– more items were sold than produced during the accounting period (i.e. some items were sold from the last period’s remaining finished goods inventory).
– some finished goods or WIP inventory have become obsolete (i.e. there is no demand for those products in the marketplace anymore).
Read more about Calculating the Cost of Goods Sold in Manufacturing.
COGM in a Manufacturing ERP
If provided with consistent accurate inputs, a proper MRP system tracks different manufacturing costs and automatically calculates both the COGM and the COGS. This perpetual inventory system takes a lot of work out of accounting, freeing up time that could be better used elsewhere.
Additionally, an MRP software allows managers to keep an eye on other KPIs, such as Overall Equipment Efficiency, Manufacturing Cost per Unit, OTIF, etc.
Read more about Important Manufacturing Key Performance Indicators.
The Cost of Goods Manufactured is an important KPI and an effective tool to gauge the production costs of a manufacturing business and use the results to identify problem areas and make improvements.
Although it is similar and related to both the Total Manufacturing Cost and the Cost of Goods Sold, the COGM is a separate concept with separate purposes.
The formula of COGM includes the Total Manufacturing Cost along with the beginning and ending WIP inventory; the Cost of Goods Sold, however, incorporates the COGM along with the beginning and ending inventory.
A perpetual inventory system for the manufacturing industry, such as an MRP system, helps businesses track their manufacturing costs and automatically calculate various KPIs, including the COGM.