What Are COGS And Why Do They Matter?
Cost of goods sold (COGS) is a term that refers to the direct costs associated with producing a product or providing a service. These costs are typically directly tied to the production of a specific product or service, and they include materials, labor, and manufacturing overhead. When you are running a direct-to-consumer business (DTC), COGS can be one of the most important, yet overlooked, numbers that you need to know for your business to be profitable.
Understanding COGS is important for businesses because it helps them to determine the profitability of their products or services. By subtracting the COGS from the revenue generated by a product or service, a business can calculate its gross profit, which is the amount of money left over after the direct costs of production have been accounted for.
What Role Do COGS Play In Your Paid Digital Advertising?
If you are running paid advertising on Facebook, Google, TikTok, or any other social media platform, COGS will be very important for you to know. Another important metric that is directly tied to your COGS is customer acquisition cost (CAC). If your customer acquisition cost exceeds your profit (in dollars), you most likely will not be profitable on your customer’s first interaction with your brand. If your brand is consumable or customers are more likely to buy more than once, not being profitable on your first customer interaction might be acceptable to you. This is where your customer lifetime value (LTV) is important to know. For example, if your profit margin is 70% for your product, which is a great margin, but that margin is only $20 in profit, your customer acquisition cost must be $20 or lower in order to be profitable on your first interaction. Is that acceptable to you? Again, this depends on your LTV, which you might not know yet if you are just getting started.
How Are COGS Calculated?
COGS is typically calculated on a per-unit basis, which means that it takes into account the specific costs associated with producing each individual product or service. This can help a business to understand which products or services are the most profitable and which may need to be adjusted in order to increase profitability.
There are several factors that can affect COGS, including changes in the cost of raw materials, fluctuations in labor costs, and changes in the overall efficiency of the production process. By closely tracking and managing COGS, businesses can ensure that they are maximizing their profitability and minimizing waste. This is especially true when you are evaluating the success of your paid advertising on social media and other networks.
In summary, COGS is a key concept for businesses to understand because it helps them to determine the direct costs of production and understand the profitability of their products and services. That being said, it is one of many that should be looked at, including LTV, CAC, and other very important KPI’s. At a base though, by closely managing and tracking COGS, your business can optimize their operations and make informed decisions about pricing and production for new products in the future.