Ever wondered where your production dollars are really going? Understanding the cost of goods manufactured is key to knowing how much you’re truly spending to turn raw materials into finished products.
Whether you’re managing a business or just starting to track your expenses, knowing this number helps you make smarter decisions and boost profitability.
In this article, we’ll explain exactly how to find the cost of goods manufactured, step by step, with simple tips and clear insights.
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Understanding the Cost of Goods Manufactured (COGM)
Knowing how to calculate the Cost of Goods Manufactured (COGM) is essential for any manufacturer. COGM represents the total production cost incurred to turn raw materials into finished goods within a specific time frame. Calculating this number helps you understand your production costs, set accurate prices, and improve profitability. Let’s break down the process together, step by step.
What is Cost of Goods Manufactured?
COGM refers to the total cost of producing products that are complete and ready for sale during a given period. It includes costs like direct materials, direct labor, and manufacturing overhead incurred throughout the production cycle. By calculating COGM, you gain visibility into your production efficiency and can identify potential areas for cost savings.
Why Is COGM important?
Understanding your COGM plays a vital role in your business for several reasons:
- Accurate Pricing: Knowing your true production costs helps set logical product prices.
- Profitability Analysis: Reveal if you’re over- or under-spending in certain areas.
- Inventory Management: Provides insight into what it costs to replenish finished goods inventory.
- Financial Statements: Essential for preparing the income statement, especially in calculating Cost of Goods Sold (COGS).
Components of Cost of Goods Manufactured
Let’s simplify what goes into the COGM calculation. There are three main components:
- Direct Materials: Raw materials physically incorporated into your products.
- Direct Labor: The cost of workers who are directly involved in manufacturing.
- Manufacturing Overhead: Indirect costs like utilities, rent, maintenance, and supervisory salaries.
Additionally, COGM takes into account the change in Work in Process (WIP) inventory—partly finished goods yet to be completed.
The COGM Calculation Formula
The calculation for COGM involves starting with opening balances, factoring in production costs, and adjusting for changes in inventory. Here’s the standard formula:
COGM = Opening WIP Inventory
+ Total Manufacturing Costs (Direct Materials Used + Direct Labor + Manufacturing Overhead)
– Closing WIP Inventory
Let’s break down the elements.
Step 1: Calculate Direct Materials Used
To find the total direct materials used:
- Opening Raw Materials Inventory
- + Purchases of Raw Materials
- – Closing Raw Materials Inventory
This gives you the cost of materials actually used in production.
Step 2: Add Direct Labor
This is the amount spent on wages for production staff working directly on the goods.
Step 3: Add Manufacturing Overhead
Include all indirect costs tied to manufacturing. Examples:
- Machinery depreciation
- Utilities for production areas
- Factory insurance
- Salaries for supervisors
Step 4: Factor In Work in Process (WIP)
WIP refers to items in production that aren’t completed at the period’s start or end.
- Add Opening WIP Inventory (these are partly completed goods at the start)
- Subtract Closing WIP Inventory (the goods not finished by period-end)
This ensures you only capture the cost of completed goods—aligning your production costs with actually finished products.
Step 5: The Final Calculation
Once you have:
- Direct Materials Used
- Direct Labor
- Manufacturing Overhead
Sum these to get Total Manufacturing Costs. Then add the Opening WIP Inventory and subtract the Closing WIP Inventory.
Example: Step-by-Step COGM Calculation
Let’s put the pieces together with an easy example.
Suppose your company makes custom furniture. Here are the figures for this month:
- Opening Raw Materials Inventory: $5,000
- Raw Material Purchases: $20,000
- Closing Raw Materials Inventory: $4,000
- Direct Labor: $10,000
- Manufacturing Overhead: $7,000
- Opening WIP Inventory: $3,000
- Closing WIP Inventory: $2,000
Follow these steps:
- Direct Materials Used
-
$5,000 (Opening RM) + $20,000 (Purchases) – $4,000 (Closing RM) = $21,000
-
Total Manufacturing Costs
- $21,000 (Direct Materials) + $10,000 (Direct Labor) + $7,000 (Overhead) = $38,000
- COGM Calculation
- $3,000 (Opening WIP) + $38,000 (Total Manufacturing Costs) – $2,000 (Closing WIP) = $39,000
So, the Cost of Goods Manufactured for the month is $39,000.
The Benefits of Calculating COGM
Calculating COGM offers several advantages:
- Clarity on Production Costs: Uncovers the true cost structure of your manufacturing operation.
- Better Profit Margins: Enables you to spot inefficiencies and reduce waste, directly impacting your profits.
- Enhanced Decision Making: Provides data-driven insights for budgeting and forecasting.
- Improved Inventory Control: Helps you manage raw materials, WIP, and finished goods more effectively.
Common Challenges in Calculating COGM
Even with a clear formula, manufacturers might run into some hurdles:
- Accurately Tracking Indirect Costs: Overhead can be tricky to allocate precisely.
- Inventory Valuation Errors: Miscounting or misvaluing WIP or raw materials distorts the COGM.
- Manual Data Entry: Human error can easily slip in if processes aren’t automated.
Overcoming These Challenges
- Implement Inventory Management Software: Automated tracking reduces mistakes.
- Regular Audits: Check inventory and production records periodically.
- Clear Cost Allocation Methods: Define how overhead gets assigned to products—common methods include machine hours, labor hours, or activity-based costing.
Practical Tips for Tracking and Improving COGM
Here are some expert tips to help you calculate—and optimize—your COGM efficiently:
- Standardize Your Data Collection
-
Set clear procedures for recording inventory purchases, usage, and labor hours.
-
Use Manufacturing Software
-
Digital tools can automatically compute and report COGM, minimizing errors.
-
Analyze Trends Over Time
-
Review your COGM each period to identify spikes or reductions in costs.
-
Train Your Team
-
Make sure all staff involved in data entry and inventory tracking understand best practices.
-
Continuously Improve Processes
- Invest in lean manufacturing and other efficiency initiatives to lower COGM.
Best Practices for COGM Accuracy
To ensure your calculations are on point, keep in mind:
- Consistent Calculation Periods: Always use the same period length (monthly, quarterly, etc.) for reliable comparisons.
- Timely Updates: Enter data as soon as transactions occur.
- Comprehensive Overhead Capture: Don’t overlook small indirect costs; they add up.
- Reconcile With Financial Statements: Regularly check COGM against cost of goods sold and balance sheet figures.
When Should You Calculate COGM?
Manufacturers commonly calculate COGM:
- At Month-End: For financial closing and reporting.
- After Major Production Batches: To analyze the costs of particular jobs or runs.
- During Budgeting Cycles: Project future expenses and set performance targets.
COGM vs. Cost of Goods Sold (COGS)
It’s easy to confuse these terms, so let’s clarify:
- COGM: Represents the cost to produce finished goods completed in a period.
- COGS: Refers to the cost of all goods actually sold during that same period.
Your COGS is typically calculated as:
COGS = Opening Finished Goods Inventory + COGM – Closing Finished Goods Inventory
Frequently Asked Questions (FAQs)
What is the difference between COGM and COGS?
COGM (Cost of Goods Manufactured) measures the total production cost of goods completed within a period, while COGS (Cost of Goods Sold) captures the cost of goods actually sold. COGM helps track manufacturing efficiency, while COGS is reported on the income statement to reflect the direct cost of sales.
Why is Work in Process (WIP) included in COGM calculations?
Work in Process helps match production costs with finished products. Adding the opening WIP and subtracting the closing WIP ensures you only consider the costs associated with goods that were completed within the period—excluding goods still in production.
What costs are considered manufacturing overhead?
Manufacturing overhead includes all indirect production costs. Typical examples are utilities, equipment depreciation, quality control, production supervisors’ salaries, and factory rent. These are necessary for manufacturing but are not directly tied to a specific product.
How often should my business calculate COGM?
Most businesses calculate COGM monthly, in line with accounting periods. However, you might recalculate after large production runs or during budgeting exercises for up-to-date insight into your manufacturing performance.
Can software help automate COGM calculations?
Absolutely! Many manufacturing and accounting software platforms can track inventories, input costs, and calculate COGM automatically. This reduces the risk of error and saves time compared to manual processes.
Conclusion
Understanding and accurately calculating your Cost of Goods Manufactured is a cornerstone of strong financial management in manufacturing. COGM sheds light on your actual production costs, highlights efficiency opportunities, and sets the foundation for accurate pricing and strong profitability. By following clear calculation steps, embracing best practices, and using the right tools, you’ll ensure your business stays competitive and financially healthy.
