Cost of goods sold (COGS) directly measures the costs incurred when producing products or providing services to customers. COGS is calculated by totaling the sum of raw materials, labor, packaging, and other expenses used during the manufacturing process, or, in the case of service-oriented businesses, all the materials and labor necessary to provide a final service to customers.

COGS is a crucial metric for businesses, and effectively managing it is essential for success. It is a major expense across all industries that directly impacts profits. A thorough understanding of the factors that contribute to COGS can give your business the opportunity to streamline operations, reduce costs, and increase your bottom line. Below are some of the strategies you can use to better manage your business’s COGS.

Inventory Management

Accurately tracking inventory levels and forecasting demand will minimize waste and reduce the cost of excess inventory. This can be done using systems to track inventory levels in real-time, or by establishing policies for regular reviews. These two methods can also be used in concert with one another, with regular reviews giving you an opportunity to reassess long-term goals while real-time inventory tracking acts as a way of reinforcing the importance of inventory management in your daily operations.

Keeping abreast of your current inventory will allow you to make adjustments that align with demand. Having sufficient inventory to meet demand is critical for the success of your business as having insufficient inventory to meet demand will lead to customer dissatisfaction and loss of sales. However, a surplus of inventory can restrict your cash flow, leaving your money tied up in assets that can’t be readily moved. Reducing excess inventory will free up capital that can be better used to invest in your company’s growth.

Supplier Negotiation

Establishing long-term relationships with suppliers and regularly reviewing your contracts will give you an advantage when negotiating with your suppliers. The terms and prices laid out in your contracts can be subject to change over time, so always be aware of what other vendors are available to you and what rates they offer. Building strong relationships with your vendors and understanding the market in which they operate will help you secure favorable terms and prices for the materials and supplies you need to produce your products or to provide your services.

Lean Manufacturing

Emphasizing the elimination of waste and inefficiency in all aspects of the production process streamlines operations. Finding ways to eliminate unnecessary steps can reduce the cost of producing products or providing services. The fundamental principles behind lean manufacturing are echoed in various production methods across a wide variety of industries. Essentially, this approach boils down to the old adage “time is money.” The less time your product spends in the manufacturing process, the lower its final cost, and lower costs widen your margins.

Automation

Investing in automated systems can reduce the need for labor and reduce the cost of production. However, it's important to carefully consider the upfront costs of automation and ensure that it will result in long-term cost savings. Labor costs are often some of the most expensive costs associated with COGS, however, automated solutions aren’t always cheaper.

Outsourcing

In some cases, outsourcing certain production processes or tasks to specialized vendors can be more cost-effective than performing those tasks in-house. However, it's important to carefully consider the potential risks and challenges associated with outsourcing, such as quality control and delivery times.

Final Thoughts

The methods for reducing COGS are influenced by a wide variety of outside factors. However, the fundamental principles behind COGS reduction are simple: simplified processes, efficient use of labor, favorable vendor contracts (i.e., understanding your suppliers’ markets), and knowing when to outsource.

By implementing the strategies above and regularly reviewing and analyzing COGS data, you can effectively control and reduce costs, allowing you to increase your business’s profitability and long-term success.