What components should be included in COGS?

COGS includes all direct costs associated with producing goods or services. This typically encompasses raw materials, direct labor, and manufacturing overhead directly tied to production. Common oversights include freight-in costs, production facility utilities, and quality control expenses. Software companies might include hosting costs and customer support, while manufacturers would include equipment depreciation and production supervision. Accurate COGS calculation is crucial for pricing decisions and understanding true profitability.

How can businesses optimize their COGS?

COGS optimization involves strategies across multiple areas: supplier management, production efficiency, and scale economics. Consider bulk purchasing discounts, negotiating better supplier terms, or finding alternative suppliers. Improve production efficiency through process automation, waste reduction, and better inventory management. For service businesses, focus on team productivity and resource utilization. The key is identifying which costs are truly necessary and finding innovative ways to reduce them without compromising quality.

How does COGS impact cash flow and working capital?

COGS directly affects your working capital needs and cash conversion cycle. Higher COGS typically requires more working capital to maintain inventory and production. Managing COGS efficiently can free up cash through better inventory turnover, improved supplier payment terms, and reduced production lead times. Industries with physical inventory should focus on just-in-time systems and optimal order quantities, while service businesses should optimize resource allocation and utilization rates to minimize costs and improve cash flow.