June 30

Direct Cost and Cost of Goods Sold (COGS)

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Direct Cost and Cost of Goods Sold (COGS)

direct cost

Tracking business expenses is very important for business owners. It allows you to improve money management and monitor the growth of your business, plays a crucial role in calculating profitability, and can help you attract investors. This article covers two key metrics which you should track on a regular basis – direct cost and cost of goods sold (COGS).

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Direct Cost: What it is and How is it Different vs Variable Cost 

Tracking costs is an essential part of the budgeting process and you need to track direct and indirect costs separately. The differences between direct costs and indirect costs are that only direct costs can be applied to producing specific cost objects (products, customers, services, projects or activity). The examples of direct costs include direct materials, direct labor, and manufacturing supplies. The examples of indirect costs are quality control costs, depreciation, and production supervision salaries.

Business costs can be variable and fixed. Variable costs vary with the output volume. Variable costs may include wages, utilities, materials used in production, etc.

Fixed costs are costs that are independent of output. They remain the same no matter what amount of goods a company produces and can’t be avoided even if no goods are produced. Fixed costs often include rent, advertising, buildings, machinery, insurance, etc.

Direct product costs such as raw materials are variable costs. Costs that are direct to a department could be variable or fixed. For example, a supervisor in the painting department would be a direct cost to the painting department.

Direct costs and variable costs are similar in nature (direct costs tend to be variable costs). They are both types of costs involved in production. However, fixed costs can be direct or indirect costs. For example, the costs of electricity, gas, phone etc. are fixed indirect costs and salaries paid to employees irrespective of hours worked are fixed direct costs.

We will touch upon more useful metrics in the article below. Don’t lose track of any of them and make sure they are aligned in calculation approaches. Use Lean Case to perform the business model calculations.


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COGS Definition and Difference vs Direct Cost 

Another metric that plays an important role in making business decisions and in setting prices is the cost of goods sold COGS) also referred to as the cost of sales. To help you understand COGS meaning, here is a simple COGS definition: Cost of goods sold is the accumulated total of all costs used to produce products or services, which have been sold. COGS is subtracted from revenues to calculate gross profit and gross margin.

 If we compared GOGS and direct costs, we must admit that COGS are broader – they include all the cost related to production of an item including cost of materials, labor, and overhead. Labor and overhead costs cannot usually be traced to the level of an item and thus often are not included in direct costs.

 

What Is Included in Cost of Goods Sold 

The cost of goods sold includes only costs that are directly related to the manufacturing goods intended for sales such as the cost of materials, labor, and manufacturing overhead. It doesn’t include indirect expenses such as distribution costs, marketing expenses, and sales force costs. You should keep in mind that COGS include direct costs only of those products which were purchased by customers during a certain period.

 Speaking about what goes into COGS, we should compare cost of revenue vs COGS.  Cost of revenue differs from COGS because it includes costs outside of production necessary to generate sales such as costs of marketing and distribution. This metric is often used by service industry because it gives a more comprehensive account of different costs associated with selling services and goods.


Difference between COGS and Expenses 

Wondering how COGS differs from operating expenses? Both of them are expenditures that incur with running business. But these two metrics represent different ways of spending resources in the process of running a company. On an income statement, expenses and COGS are segregated because operating expenses are not directly related to producing products or services. Examples of operating expenses include insurance costs, sales and marketing, legal costs, etc.

 As you see, direct cost and COGS are among the crucial metrics in business planning and decision criteria for investors. There are much more factors you need to consider when preparing for the next investment raising round. The best way to keep track of all the important criteria and ensure that your presentation is convincing and not missing crucial elements is to use Lean Case. With the help of the system you can easily develop comprehensive business models your investors will be grateful for.

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