Q&A: As an artist & crafter, how do I figure my Cost of Goods Sold?

This is a carry-over from the last couple weeks…Joell A. wanted to know exactly what is Cost of Goods Sold…and then Katie L. followed up asking how to figure out Cost of Goods Sold for retail sellers…and now Terri M. asks about figuring Cost of Goods Sold for manufacturers…

I understand what COGS is, but how do I calculated it since I’m making my inventory items from scratch? As an artist & Etsy seller, how do I figure out my Cost of Goods Sold?
- Terri M.

Terri, this one is a doozy, but there’s a lot to go into figuring out your COGS if you create your own inventory…

For manufacturing businesses (which includes crafters, most artists, jewelry designers, fashion designers and most Etsy handmade sellers), things get a little bit more complicated. You have three categories of inventory, and they all need to be tracked separately:

  • Raw Materials
  • Works in Progress
  • Finished Goods

As you create your products, your inventory moves from Raw Materials to Works in Progress and then finally to Finished Goods. Usually, this happens pretty quickly, especially if you make each item to order.

If you use bookkeeping software, all of these calculations happen behind the scenes, so you’ll never have to worry about figuring out these amounts yourself.

If you do your bookkeeping manually, here’s what you have to do at the end of each year:

Raw Materials
In a general sense, your Raw Materials include:

  • The cost of the raw material
  • + Plus sales tax paid by you
  • + Plus delivery fees to get the item to you
  • - Minus any discounts you received
  • = Raw Materials

To calculate your Total Raw Materials for a period, you start with the Raw Materials you had at the beginning of the period (from your physical count). If this is your first year in business, this number is zero.

  • Beginning Raw Materials (on December 31, 2009 from your physical count)
  • + Plus purchases of Raw Materials (for Jan – Dec 2010)
  • - Minus Ending Raw Materials (on December 31, 2010 from your physical count)
  • = Total Raw Materials Used in 2010

Works in Progress
Usually, most artists and crafters don’t have too many items sitting in Works in Progress. The only time you really need to know this number is at the year end, when you are preparing your income tax return. You can estimate the cost of the items in this category, but it’s pretty easy to figure out the exact figure.

In a general sense, Works in Progress equals:

  • Total Raw Material costs (from above)
  • + Plus Direct Labor cost
  • + Plus Manufacturing Overhead
  • = Works in Progress

Direct Labor cost is the cost of having employees or outside contractors produce each item. This does NOT include the business owner’s time, or any administrative, selling or marketing labor costs.

Manufacturing Overhead is the total of the expenses you have spent to create each item. This may be a portion of your rent, utilities, or supplies not included in Raw Materials. Generally, unless the Manufacturing Overhead is significant or easy to calculate, most people just estimate or ignore it.

Cost of Goods Sold
Once you know your Works in Progress total, you can start to figure your Cost of Goods Sold. First, however, you need to figure the Cost of Goods Manufactured. (It’s never simple, is it?)

  • Total Raw Materials Used (calculated above)
  • + Plus Direct Labor for the period (from Jan 1, 2010 – Dec 31, 2010)
  • + Plus Manufacturing Overhead for the period (from Jan 1, 2010 – Dec 31, 2010)
  • + Plus Beginning Works in Progress (on December 31, 2009 from your physical count)
  • - Minus Ending Works in Progress (on December 31, 2010 from your physical count)
  • = Cost of Goods Manufactured in 2010

Finally, once you know your Cost of Manufactured Goods, you can then figure out your Cost of Goods Sold.

  • Beginning Finished Goods Inventory (on December 31, 2009 from your physical count)
  • + Plus Cost of Goods Manufactured
  • - Minus Finished Goods Inventory (on December 31, 2010 from your physical count)
  • = Cost of Goods Sold in 2010

Thank goodness you only have to do this once a year!

Frankly, most manufacturers who use a manual bookkeeping system estimate their Cost of Goods Sold. You take a look around the studio, and add up the costs of your Raw Materials, your Works in Progress, and the Finished Goods and just eyeball it. I’m not saying it’s accurate or good business practices – but it is very common and it gets the job done.

Your turn
Do you know what your Cost of Goods Sold is?

If you have a money or business question for me, send an email and I’ll try to answer it during the weekly Q&A.