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Many businesses use a simple process to determine cost of good sold, using the calculation as a means of measuring the what type of progress the business is making in terms of selling the goods and services that are produced and offered for sale to consumers. One of the key aspects of most of the ways used to determine cost of goods sold (COGS) is to consider the amount of inventory on hand at the beginning of a period, and compare that to the amount of inventory on hand at the end of that same period. This approach allows for what is known as first-in-first-out (FIFO), one of the most common and effective means of gauging company activity.
A basic formula that is used to determine cost of goods sold begins with identifying the value of the inventory that is on hand on the date considered to be the first day of the period under consideration. From there, any purchases or additions to that beginning inventory are taken into consideration and bundled in with the inventory on hand the first day of the period, making it possible to identify what is known as the total inventory for that period. From there, an assessment of all disbursements from that inventory between the first day of the period and the final day are subtracted from that total inventory figure. That which remains is considered the cost of goods sold.
A variation on this basic formula used to determine cost of goods sold is to once again start with the opening value of the inventory as of the first day of the period under consideration. At the end of the period, the total value of the disbursements made are deducted from the beginning amount. All additions to the inventory are then added back into the active inventory figure, making it possible to arrive at the current value of the inventory as of the last day of the period. By subtracting the beginning balance from the ending balance, a company can determine cost of goods sold and decide if the month’s activity was within expectations, or if the results indicate some sort of emerging trend.
Many companies will use some approach to determine the cost of goods sold on at least a monthly basis, often using the calendar month to determine the beginning and ending dates for the period. Taking the time to make the calculation can often provide valuable insights into how well the business is doing in terms of producing goods that are quickly sold and do not inflate the inventory of finished goods on hand. If the calculation indicates that the inventory is increasing beyond what is considered a reasonable level, company officers may determine to curtail production until the inventory is lower, making it possible for what is coming into inventory each month and what is going out to achieve a more agreeable balance.
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