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Lesson 10. Managing Your Budget > Cost of Goods Sold and Gross Sales - Pg. 45

Managing Your Budget 45 Cost of Goods Sold and Gross Sales In the manufacturing and wholesale/retail environments, it is imperative to know the cost of goods sold (COGS) in the budgeting process. You must differentiate among categories of costs in the budgeting process. Knowing COGS also allows you to determine gross sales before deducting operating expenses. The formula--in this case, exemplified by a wholesale or retail environment-- is best reflected by an example: Sales Minus Minus Minus Equals Cost of materials/product Allowances and rebates Returns Gross sales $200,000 $50,000 $5,000 $5,000 $140,000 The added-up deductions ($60,000) represent the COGS. Gross sales represent the total sales minus the COGS. The formula for a manufacturing environment is more amplified than this, though, so you are encouraged to purchase a good accounting textbook that defines and exemplifies all these formulas. Plain English COGS in a manufacturing environment include raw materials, manufacturing labor, pack- aging, depreciation expenses of manufacturing equipment, transportation of raw materials, and other expenses directly associated with the manufacturing process. Breakeven Analysis Breakeven analysis is a mathematical process in which you determine the level of sales required to pay off the costs of goods sold and operating expenses. The formula is as follows: Total Fixed Costs ÷ (Unit Sale Price - COGS - Unit Variable Cost) Total fixed costs represent those monthly costs that will be incurred, more or less at the same level, whether or not you make a sale. The unit variable cost represents costs that vary from month to month and are impacted by sales or other activities such as advertising, special events, and other nonmonthly activities. Let's take the example of a company that projects next year's fixed costs to be $500,000; the sale price per unit of the product is $5, COGS is $2.50, and the anticipated per-unit variable cost will be $1. The breakeven analysis would be as follows: $500,000 ÷ ($5.00 - $2.50 -; $1.00) = 333,333 In other words, the point in time that 333,333 units of the product are sold is when the company will cover all anticipated costs for the year. Caution Breakeven analysis relies exclusively on projection of sales and expense. The level of ac- curacy of your projections directly correlates to the accuracy of your breakeven analysis. An Example of Budget Analysis Not every budgeting situation is the same. The following example, though rather simple, attempts to guide you through the learning process of analyzing departmental costs and their relationship to sales.