How to calculate the cost of goods manufactured

Here you can learn all about the costs of goods manufactured, how to review them, and all the tools you need to make this calculation.

Man in the office calculating finished goods inventory
Last updated: 02.11.2022

Goods manufactured is a term used for the cost of the inventory that is produced during a period.

The cost of goods manufactured (COGM) is an important metric, especially for manufacturing businesses, because it can affect profitability, which is the ultimate goal of any business.

In this article, we will help you understand:

  • What is the cost of goods manufactured (COGM)
  • How to find the cost of goods manufactured
  • What are the various direct and indirect costs that are involved
  • What is the formula for calculating COGM
  • Why manufacturers need to track COGM
  • How you can efficiently measure your COGM

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How to calculate average inventory: use Excel — Microsoft Excel is a powerful spreadsheet application that can be used to calculate average inventory. There are many free tutorials available online that can show you how to use Excel for this purpose.

What is the cost of goods manufactured (COGM)?

The cost of goods manufactured (COGM) refers to all the costs involved in producing a product, including direct labor, indirect labor, raw materials, and overhead costs.  

COGM is a useful accounting metric because it can be used to measure the performance of production and manufacturing costs with target costs. It is used to determine the profit margin and other costs related to manufacturing or selling products, so knowing this number is crucial for any business owner or manager.  

How to calculate the COGM?

To calculate COGM, you’ll want to break it down into its three components: 

  • Direct material costs  
  • Direct labor costs  
  • Overhead costs  

Materials cost you money when you buy them, so you know exactly how much material is being used. Labor is easier because it’s paid for by check at the end of each month. Other costs can be harder to track because they may not be as directly related to the production process as materials or labor are.  

For example: 

  • Utilities — Electricity used in running machines. Insurance premiums paid on machinery, freight charges incurred, etc.  
  • Factory and warehouse rent  
  • Depreciation of machines (or equipment)  
Calculator, pen, and a bank statement sat on top of a table.

The COGM formula 

COGM = Beginning inventory + Costs incurred during production — Ending inventory

The beginning inventory of raw materials and work-in-progress inventory is subtracted from the cost of goods manufactured because those items were used for production.  

The result is called the cost of goods manufactured (COGM), which represents the total amount paid for direct materials and direct labor costs associated with manufacturing the products you sell. This number can be used to compare actual manufacturing costs to planned manufacturing costs. COGM can be calculated manually or automatically by using an ERP software package such as Katana

Why is understanding COGM important?

As a manufacturer, your survival depends on profitability.  

And your profitability depends on identifying all sources of costs. Your inventory is the core part of your costs. By understanding, measuring, and tracking COGM, you keep in touch with the pulse of your business.  

Without knowing COGM, it is almost impossible for a manufacturer to reduce its costs and improve profitability.  

Financial analysts and business managers use COGM to determine whether a company’s products are profitable enough to continue selling them or if they need to change its supply chain to lower those costs.  

Example calculation of the COGM 

To perform the COGM calculation, you need to identify the three important calculation parts.  

1. Beginning inventory 

You need to find out the number of finished goods on hand at the end of the previous month. Next, you add in all raw materials purchased during that same period. Finally, you subtract any ending work-in-progress (WIP). 

Beginning Inventory = Finished Goods + Purchases — Ending WIP 

2. Costs incurred during production

  • Material costs — Track during the purchase 
  • Labor costs — Track at the time of invoice payment 
  • Depreciation of machines — This cost can vary widely depending on how long your company has been in business and what kind of equipment you have. For example, if your company has been around for 30 years and still uses equipment purchased back then (or worse yet before computers were even invented), depreciation might be as low as $10 per year per the machine. 
  • Factory rent — Depends entirely upon location and other factors specific to each situation. 
  • Utilities — Electricity bills are easy to figure out based on kilowatt usage over time. Still, heating/air conditioning bills can be trickier because sometimes businesses use their generators instead of paying someone else for heat/cooling services. 

3. Ending inventory

Since you already have the beginning inventory, subtract that amount from the total sales for the period to get your ending inventory. 

This is a simplified example:  

Ending Inventory = Beginning Inventory + Purchases — Total Sales 

Now that you have the beginning inventory, ending inventory, and costs incurred during production, you can calculate the COGM using the COGM equation:  

COGM = Beginning inventory + Costs incurred during production — Ending inventory 

Cost of Goods Manufactured (COGM) vs. Cost of Goods Sold (COGS)

COGM is the total cost to make products for sale.  

The cost of goods sold (COGS) is the actual expenses related to producing those products. 

COGM does not include marketing or distribution costs, it only includes direct labor, materials, and factory overhead costs associated with producing finished goods inventory. On the other hand, COGS is an accounting term used to describe the total amount spent on manufacturing a product before it’s sold.  

For example, if you purchase $1000 worth of raw materials but don’t sell them until six months later, you would recognize that $1000 expense in your books as “cost of goods sold” 

Cost of goods manufactured (COGM) vs. total manufacturing cost (TMC)

Total manufacturing cost (TMC) is the total cost of all the materials and labor that go into making products for sale.  

COGM calculations include: 

  • Direct material costs  
  • Indirect material costs  
  • Direct labor costs  
  • Factory overhead (indirect labor and fixed expenses)  

TMC calculations only include direct material costs because they do not include indirect material or factory overhead expenses. 

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Using ERP software for COGM calculation and tracking

When a company produces its products, you need to have a solid system for calculating COGM.

If you don’t, you could lose money or even go out of business because of miscalculations or inaccurate information. Luckily, some tools make it easy to calculate COGM and keep track of the results. ERP software such as Katana allows businesses to use data from their operations to calculate COGM and other important figures like inventory value and sales revenue.

ERP systems can help track COGM by keeping track of raw materials as they pass through each production stage and into the finished goods inventory.

This means that when it comes to the time for accounting purposes, all those numbers will already be there and ready to go.

Keeping your finances and bookkeeping up to date

COGM is a major concern for companies that produce goods.
If your COGM is higher than your selling price, then you aren’t making a profit on each item sold — and this can be bad news for your business. If you don’t know how much COGM you have, you won’t be able to make informed decisions about pricing or product development.

Making sense of COGM and having efficient systems to measure and track them is key to your survival as a manufacturing business.

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