The account on your income statement called Cost of Goods Sold can be confusing to non-accountants. In this article, we’ll attempt to de-mystify it and explain how it works.
Cost of Goods Sold is an account in your Chart of Accounts that is a very special type of expense. It is the amount of direct costs of items or services that were sold by the company. It is related to inventory and the services you provide, and it helps to see the flow of inventory transactions to understand the big picture.
The largest component of Cost of Goods Sold for a fitness business relates not to the Items you sell, but to the services you provide and is in the form of payroll. If at all possible, it is helpful to separate your payroll into two categories:
1. Administrative work – tasks performed no matter how many members or classes you have (marketing, front desk, cleaning, etc.)
2. Cost of delivering your service – the hours your coaches are working and directly relating to the members (coaching, creating programs, goal setting or accountability, for example). This should increase and decrease with the number of members and classes.
It is also important to understand how inventory affects your business even though it does not have a large effect on your cash flow. When you purchase an inventory item for sale, it’s considered an asset (not an expense yet) in your company. When you sell an inventory item, the asset is reduced and the Cost of Goods Sold account is increased, moving the item from an asset to an expense. It’s no longer an asset once it’s sold, and the cost of the item sold reduces your profit and is expensed into the Cost of Goods Sold account.
Some accountants will abbreviate the Cost of Goods Sold account to COGS, and you might hear them call it that.
In the case of the retail portion of fitness businesses, the cost of goods sold is the amount that was paid for the inventory items to be sold.
At any point in time, the cost of items you purchase are in two different accounts:
1. The unsold items are reflected in the asset account, Inventory, on your Balance Sheet report.
2. The sold items are reflected in the Cost of Goods Sold account, on your Income Statement report.
It’s important that the Cost of Goods Sold balance is accurate, because there are many good things you can learn from it when you compare it with inventory. You can learn how fast your inventory is selling, and you can determine your gross profit margin.
Since inventory is not a large concern for fitness businesses, we recommend coding all inventory purchases to a Cost of Goods Sold subaccount called Purchases. Then at the end of the year reduce that amount by whatever is left in inventory to arrive at accurate Cost of Goods Sold and Inventory amounts. This does mean if you want to run inventory type reports throughout the year, the amounts in these accounts will need adjusted first.
If you have further questions about the Cost of Goods Sold account, feel free to reach out any time.