Businesses use a simple process to determine the cost of goods sold (COGS) by comparing the amount of inventory available at the beginning and end of a period. This allows for the first-in, first-out (FIFO) method to evaluate business activity and make decisions about production and inventory levels.
Many businesses use a simple process to determine the cost of a good sold, using the calculation as a means of measuring what kind of progress the business is making in terms of selling the goods and services that are produced and offered for sale to consumers. One of the key aspects of most of the ways used to determine the cost of goods sold (COGS) is to consider the amount of inventory available at the beginning of a period and compare it with the amount of inventory available at the end of that same period. This approach allows for what is known as first-in, first-out (FIFO), one of the most common and effective means of evaluating business activity.
A basic formula used to determine cost of goods sold begins with identifying the value of inventory available on the date considered to be the first day of the period considered. Thereafter, any purchases or additions to that beginning inventory are accounted for and included with the available inventory on the first day of the period, identifying what is known as the total inventory for that period. From there, an assessment of all disbursements of that inventory between the first day of the period and the last day is subtracted from that total inventory figure. What remains is considered the cost of goods sold.
A variation on this basic formula used to determine cost of goods sold is, once again, to start with the opening value of inventory as of the first day of the period under consideration. At the end of the period, the total value of the disbursements made is deducted from the initial amount. All additions to inventory are added back to the active inventory figure, allowing you to arrive at the current value of inventory as of the last day of the period. By subtracting the beginning balance from the ending balance, a company can determine the cost of goods sold and decide whether activity for the month was within expectations, or whether the results indicate some type of emerging trend.
Many companies will use some approach to determine cost of goods sold on at least a monthly basis, often using the calendar month to determine period start and end dates. Taking the time to do the math can often provide valuable insight into how well the business is doing in terms of producing goods that sell quickly and not inflate the inventory of finished goods on hand. If the calculation indicates that inventory is increasing beyond what is considered a reasonable level, company officials may determine to reduce production until inventory is lower, allowing what goes into inventory each month and what comes out to achieve higher performance. Nice balance.
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