Cost of Goods Sold in Ecominate
With Ecominate there are two options for calculating cost of goods sold. By default, users can enter a "landed cost" for all of their products using the product settings bulk upload sheet. Ecominate also has an option for FIFO (first-in first-out) cost of goods sold accounting that syncs with the purchase ordering system. The inventory accounting method that you choose will flow through all of the analytics and accounting tools in Ecominate. To change your cost of goods sold tracking method inside Ecominate, navigate to the settings page and change the accounting method using the dropdown.
Why does COGS matter to my business?
In most countries, like the United States, a government tax collection agency like the Internal Revenue Service (IRS) requires cost of goods sold to be reported along with a beginning and year end inventory value. Cost of Goods Sold is considered an expense, therefore the larger it is, the lower the taxable income. E-commerce sellers must choose an accounting method for tracking inventory purchases and reporting what inventory is left over at the end of the year. As one of the most significant cost drivers to your business, accurate cost of goods sold accounting is an essential component for maintaining accurate bookkeeping.
What are the different ways of calculating COGS?
In a simplified way, cost of goods sold is calculated as follows:
Beginning Inventory + Inventory Purchases – Ending Inventory = Cost of Goods Sold. The formula makes sense since anything left over after inventory purchases are accounted for is no longer in stock or available for sale. More complicated situations can arise if inventory is kept in a 3PL like Amazon FBA where inventory is often lost, damaged, or returned to inventory. All of these changes must be tracked and reflected on the seller's books to maintain an accurate valuation of inventory. How exactly does this tie into inventory that is sold on Amazon? We'll first dive into the three general methods for inventory accounting and then in the next two sections explore how two of those methods can be applied inside Ecominate.
There are three general ways of calculating COGS:
- FIFO (First in, First out) – First-In, First-Out (FIFO) is the most commonly used and accurate method for calculating the value of inventory and cost of goods sold (COGS) for e-commerce sellers. The FIFO Method assumes that inventory purchased first is sold first and that the newest inventory remains unsold. The cost of the older inventory is assigned to the cost of goods sold and the cost of the newer inventory is assigned to ending inventory. This means you will use the oldest inventory first to fill orders. FIFO ensures that the ending inventory values on the balance sheet are indicative of current market prices for the items. As items purchased at earlier dates are pulled from inventory for sale, the inventory on the books at the end of the month consists of more recently purchased inventory. FIFO most closely matches your ending inventory on your balance sheet to your current costs and is also generally seen as the preferable method amongst e-commerce accountants.
- Average Cost (also called weighted average cost) – The average cost method is used to track inventory using an ‘average’ cost, or by averaging the costs of all the quantities that are in stock divided by the total cost of those purchases. this method can be used when the inventory prices change from purchase to purchase and you want consistency and ease of use. The weighted average method smooths out price changes so you have a steady stream of cost instead of sharp increases and decreases. This does require a bookkeeper to calculate a new average cost after each inventory purchase cycle.
- LIFO (Last in, First out) **Not supported by Ecominate –This method uses the most recent inventory first for cost of goods sold calculations. LIFO COGS will reflect the current or most recent costs and allows the business to match current revenue with the current costs of the inventory. The Balance Sheet will show inventory at the oldest inventory costs and may not represent current market value. LIFO is more difficult to maintain than FIFO because it can result in older inventory never being shipped or sold. LIFO also results in more complex records and accounting practices because the unsold inventory costs do not leave the accounting system. LIFO is not generally used for e-commerce accounting.
How FIFO fits into Ecominate
Most accountants would recommend the FIFO method for their e-commerce clients. However, since many sellers house inventory inside 3PLs like Amazon FBA this method used to be incredibly complex. Accountants would need to pull many different inventory reports from inside Amazon to first reconcile inventory and track dozens of inventory adjustments and then match against numerous purchase orders during the accounting period. Ecominate has automated this task entirely and FIFO can be set up easily by entering purchase orders inside Ecominate and letting us do the heavy lifting. A more thorough explanation of this process is included here.
Setting up Average Cost in Ecominate
Inside Ecominate, users have an option to assign a single average cost to each of their SKUs or to assign different average costs on a date range basis. Since costs often change during accounting periods, the average cost must be regularly updated to reflect those changes. For inventory accounting purposes, the average cost is the easiest to set up but also less accurate. Follow this article for a walk through of setting up average cost accounting inside Ecominate.