Gross profits look great on a balance sheet. When you sell a lot of inventory, your ledger steadily ticks up from the beginning balance at the start of the financial year. But sales revenue only tells part of the story; you also have to factor in the costs of generating your inventory in the first place. For this, businesses use a metric called the cost of goods manufactured (COGM).
Calculating COGM helps company leaders assess the financial impact of their production process. Here’s a rundown of the general idea behind the cost of goods manufactured, how to calculate COGM, and how knowing COGM can help you optimize manufacturing and improve profitability.
What is cost of goods manufactured (COGM)?
Cost of goods manufactured (COGM) is the total cost incurred by a company to produce goods during a particular period. It includes all the direct costs and indirect costs associated with the production process. COGM is used in managerial accounting to calculate the material costs related to a company’s products. Knowing COGM helps companies understand how fixed expenses and other costs related to production impact their bottom line.
How to calculate cost of goods manufactured
Calculating the cost of goods manufactured (COGM) requires five inputs that contribute to a product’s total manufacturing costs. Those inputs are:
- Direct materials used: The cost of raw materials consumed in the manufacturing process.
- Direct labor: Direct labor costs cover the price of labor directly involved in the production of goods, such as wages paid to workers directly involved in the manufacturing process.
- Manufacturing overhead: This includes all other indirect manufacturing costs, such as factory overhead costs (including factory rent or mortgage payments), utilities, depreciation on equipment, indirect labor, and indirect materials. These costs are necessary for production but aren’t directly attributable to specific product units.
- Beginning work in progress (WIP) inventory: Beginning WIP inventory is the cost of unfinished goods from the previous accounting period.
- Ending work in progress inventory: Ending WIP inventory is the cost of unfinished goods remaining in the current accounting period.
You’ll then plug these inputs into the COGM formula, which is:
COGM = (direct materials used + direct labor + manufacturing overhead + beginning work in progress inventory) – ending work in progress inventory
Calculating COGM helps businesses to make pricing decisions and evaluate the efficiency of the manufacturing process. Note that COGM calculations only consider expenses connected to the manufacturing process; COGM doesn’t include indirect expenses, such as raw materials purchased in bulk and used to make many different products. Other business expenses without connection to manufacturing, such as HR administrative expenses or marketing costs, also would not factor into a COGM value.
Example of COGM
To see how the cost of goods manufactured formula functions in the real world, let’s consider a hypothetical scenario for a company that manufactures furniture. Here are the details for the business’s accounting period:
- Direct materials purchased: $50,000
- Direct labor costs: $30,000
- Manufacturing overhead: $20,000
- Beginning work in process inventory: $10,000
- Ending work in process inventory: $15,000
We can then plug these inputs into the established formula and calculate COGM as follows:
COGM = ($50,000 + $30,000 + $20,000 + $10,000) – $15,000
Based on this example calculation, the total manufacturing cost for this specific period is $95,000.
COGM vs. COGS
Cost of goods manufactured (COGM) and cost of goods sold (COGS) are both crucial elements found on companies’ financial statements. While they are related, they represent different stages in the production and sale of goods. Here’s a breakdown of how COGM and COGS factor differently in a company's total production costs.
Relation to costs incurred
- How they’re similar: Both COGM and COGS relate to the total manufacturing cost of a product.
- How they’re different: COGM calculates the total cost incurred by a company to produce finished goods during a certain period. COGS, on the other hand, refers to the total cost incurred to produce goods that were actually sold during that same period.
- How they’re similar: Both COGM and COGS include the direct cost of labor.
- How they’re different: COGM includes direct materials used, direct labor, manufacturing overhead, and adjustments for the beginning and ending work in process inventory. COGS includes all these, but it adds the beginning inventory of finished goods and subtracts the ending finished goods inventory.
Relation to sales revenue
- How they’re similar: Both COGM and COGS measure costs related to finished products ready for customers to buy.
- How they’re different: COGM reflects the cost of the ending finished goods inventory ready to be sold. COGS reflects the cost of goods completed that have left the inventory and been sold to customers.
Cost of goods manufactured FAQ
Is cost of goods manufactured the same as total manufacturing cost?
No. The cost of goods manufactured (COGM) specifically represents the total cost to produce finished goods, including direct materials, direct labor, and manufacturing overhead. Total manufacturing cost may encompass broader expenses related to manufacturing, including additional costs such as maintenance, utilities, or other overhead not tied directly to the production of finished goods.
What is a COGM schedule?
A COGM schedule is a detailed statement or report that outlines the various components contributing to the total cost of goods manufactured during a specific accounting period. It typically includes the breakdown of direct materials used, direct labor costs, manufacturing overhead, and beginning and ending work in process inventory and calculates the total cost of goods produced by a company.
Does cost of goods manufactured go on an income statement?
The cost of goods manufactured (COGM) itself doesn't directly appear on a company’s income statement. Instead, components of the COGM, such as the cost of direct materials used, direct labor, and manufacturing overhead, are transferred to the income statement as part of the cost of goods sold (COGS) section.