How to Calculate the Cost of Goods Manufactured (COGM)

By Indeed Editorial Team

Published October 18, 2021

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Many organizations regularly calculate and monitor their production costs. By doing so, they can identify any problems in their production processes and devise effective solutions. Understanding how to calculate the cost of goods manufactured (COGM) can help you maximize a company's profitability. In this article, we discuss what COGM is, outline how to calculate it, explore determining your work in progress inventory, highlight how to use COGM calculate the cost of goods sold, explore the importance of calculating COGM, and provide examples of COGM calculations.

What is the cost of goods manufactured?

The cost of goods manufactured (COGM) is an accounting term that refers to a statement showing a company's total production costs within a specific period. COGM calculates the total cost of converting raw materials into finished products that are ready for sale. Businesses factor in variables like labour cost, raw materials, and other overhead costs when calculating their COGM. Some experts also refer to COGM as the cost of goods completed or the cost of goods produced.

Related: What is Quantitative Analysis?

How to calculate COGM

Follow these steps to calculate COGM:

1. Understand the COGM formula

Using the right formula is essential for getting an accurate COGM. The formula for calculating COGM is straightforward and involves simple calculation. The formula for calculating COGM is:

COGM = Beginning WIP inventory + total manufacturing cost - ending WIP inventory

2. Choose a period for calculation

Like most other financial calculations, it's necessary to select a specific period to calculation applies to. This can vary according to the type of organization for which you're calculating. For example, fast-moving stores that sell perishable products may want to calculate their COGM daily, weekly, or monthly. In contrast, larger companies or factories that produce more durable goods may calculate their COGM quarterly or annually.

3. Determine your beginning work in process inventory

The beginning work in progress (WIP) inventory of a company is the value of products that are still in production. Companies and businesses can accurately determine this value at the end or start of a new business period. For example, if Morty Manufacturers produced 5,000 products last month but are yet to complete 1,500 of them, their beginning WIP inventory for the new month is 1,500 products. As the company is going to incur costs to complete the production of those goods, they contribute to your COGM.

4. Calculate your total manufacturing cost

The next step in the formula is calculating the total manufacturing cost for the period. The total manufacturing cost includes the cost of direct materials, labour, and other manufacturing overhead costs. Consider this overview of the various elements:

Direct materials

This refers to the cost of the raw materials the company used in the production of its goods. These can be both direct and indirect materials. Usually, companies also maintain a raw material inventory account. This statement records all raw materials that are waiting for use in production. For example, when companies purchase raw materials for storage, they record them on the credit side of the raw material inventory. Similarly, when a company takes out raw material for production, they record it on the debit side of the raw materials inventory.

When a company takes out raw materials for use in production, it deducts the amount from the raw materials inventory and transfers it to the beginning WIP inventory. To determine the number of direct materials used in production, it's essential you consider the beginning and ending balance in the raw materials inventory. The formula is beginning raw materials inventory balance + raw materials purchases - ending raw materials inventory balance = direct materials used in production.

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Labour

The labour cost refers to the amount a company uses to pay its employees. This includes salaries, commissions, bonuses, and other work benefits. Determining this variable is relatively straightforward, as most companies have time logs for their employees. Multiply the number of hours each employee spends at work by the company's hourly rate. Remember to factor in overtime costs and other payment agreements with employees.

Manufacturing overhead costs

A company's overhead manufacturing costs are indirect expenses it incurs regardless of whether it's producing. This includes factory rent, cost of equipment maintenance, cost of licensing, and other regulatory fees. Usually, companies have records of these costs in their cash flow statement.

Determining your ending WIP inventory

The ending WIP inventory is the value of goods the company is yet to produce at the end of a specific period. To obtain the ending WIP inventory value, add the beginning WIP inventory and total manufacturing cost, and then subtract that value from the COGM. For example:

If a company starts the month with a beginning WIP inventory of $10,000, spends $35,000 on manufacturing costs, and has a COGM of $33,000, its ending WIP inventory is $10,000 + $35,000 - $33,000 = $12,000.

Using COGM to find the cost of goods sold (COGS)

After a company has calculated its COGM for a year, it transfers this value to a finished goods inventory account. This is a final inventory account of goods, products, and services ready for sale to end-users. Companies can use this inventory and the COGM value to determine the cost of goods sold. Just like other inventories, the finished goods inventory also has a beginning balance for goods it didn't sell before the start of the business year and an ending balance for goods it's unable to sell at the end of the business year.

The formula to calculate the cost of goods sold is the beginning finished goods inventory balance + COGM - ending finished goods inventory balance. For example, if a company has a beginning finished goods inventory balance of $1,000, a COGM of $10,000, and an ending finished inventory balance of $800, that means COGS = $1,000 + $10,000 - $800 = $10,200.

Importance of calculating COGM

Here are some reasons it's important for companies to calculate their COGM:

Allows companies to assess their profitability

The amount of profit a company makes depends on the difference between its costs and revenue. For that reason, companies calculate COGM to monitor their production costs and determine if it's too high or low relative to their revenue. For example, a company makes $100,000 in sales revenue and has a COGS of $75,000, while a different company makes $85,000 in sales revenue with a COGS of $40,000. Although the first company makes more sales, the second company is still the more profitable company. Calculating the COGM is essential for companies to determine the extent of their profit.

Related: How to Calculate Net Income for an Individual and a Business Organization

Informs corporate strategy

By calculating COGM, companies can know their production cost compared to their revenue. With this information, they can devise strategies to maximize profits and modify their business strategies. These actions may include marketing, new partnerships, or automation.

Helps identify money losses

A high COGM means high production costs, which can identify inefficiency in the production process. While many factors can contribute to a high COGM, such as the growing cost of labour or land, the company's production process is usually the first place to check. This can help organizations identify any issues in production and solve them.

Related: How to Calculate Gross Income Per Month for Individuals and Businesses (with Examples)

Examples of calculating COGM

Here are some examples of calculating COGM for companies within a specific period:

Example calculation of COGM for a factory

Here is an example of calculating the COGM of a factory:

Great Star Factory starts its business year with a beginning WIP inventory cost of $6,000. It spends $12,000 on direct materials, $9,000 on labour, and $3,000 on overhead manufacturing costs in the year's production. This puts the total manufacturing cost of Great Star Factory at $24,000. After calculating its inventory at the end of the year, Great Star Factory had an ending WIP inventory of $3,500.

The formula to calculate COGM = Beginning WIP inventory + total manufacturing cost - ending WIP inventory. For Great Star Factory, that calculation is $6,000 + $24,000 - $3,500 = $26,500.

Example calculation of COGM for a soda company

Here is an example of a calculation for soda manufacturing company's COGM:

Gracey's Soda Manufacturing Company has $230,000 worth of products in its beginning WIP inventory for the business year. Throughout the year, Gracey's spent a total of $85,000 on direct materials, $110,000 on labour costs, and $45,000 on utilities, rent, and other manufacturing overhead costs. At the close of the business year, Gracey's recorded an ending WIP inventory of $145,000.

COGM = Beginning WIP inventory + total manufacturing costs - ending WIP inventory. To find the total manufacturing costs, add direct materials, labour, and other overhead manufacturing costs. Total manufacturing cost = $85,000 + $110,000 + $45,000 = $240,000. COGM = Beginning WIP inventory + total manufacturing cost - ending WIP inventory. For Gracey's, COGM = $230,000 + $240,000 - $145,000 = $325,000.

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