September 13th, 2011 @ Tom Willett
While the COGS (cost of goods sold) and OE (operating expenses) are both expenses; but they are different. If you had no sales, you would basically have no COGS.
COGS is an expense that is incurred because a sale takes place. For example in a pizza shop, the dough and toppings (sauce, cheese, pepperoni, etc.) are the COGS related to selling the pizza.
OE are the basically fixed monthly cost of running your business. Regardless of the level of your sales, the rent, utilities (electric, gas, phone, etc.) are the same.
Here is how to test to determine if an expense is a COGS or OE. If you had no sales in a month, would you incur the expense? For example, is a pizza box an OE or COGS? If you had no sales would you need to buy more pizza boxes – no, thus pizza boxes that some might consider an OE supply expense is actually a COGS expense.
Having properly separated COGS from OE, we can begin to make some important calculations related to your business. One of these is Gross Profit.
Total Sales less total COGS equals Gross Profit. By dividing the Gross Profit by the Total Sales you obtain the Gross Profit Margin. For example
Total Sales $40,000 100%
Total COGS -$21,000 52.5%
Gross Profit $19,000 47.5% ($19,000/$40,000)
Having determined Gross Profit, how is your business doing? In this example, the Gross Profit is 47.5%. Is this good? The answer is determined by the industry you are in. The 47.5% may be excellent in one industry but not in another.
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