Calculating direct materials
Let’s break this down further by showing the calculation of raw materials expenses per unit as part of COGS.
Say you’ve started a hobby business selling handmade scented candles. You purchase the necessary equipment, raw materials, and supplies. In order to calculate COGS, you need to know the value of raw materials that goes into one unit.
Let’s go over the raw materials cost and how it relates to COGS.
The raw materials are:
- Fragrance oil
- A wick
- A glass jar
- A warning label
- A brand label
You buy the primary material, wax, at $0.07/oz. You decide that for a good size, each candle will use 6oz. of wax.
$0.07 x 6 = $0.42
That’s $0.42 worth of wax for each candle.
Each candle needs fragrance oil at an amount of 6% of the wax weight. So, multiply six percent by the total wax weight to find the amount of fragrance oil.
0.06 x 6oz = 0.36oz
Multiply this by the total price of fragrance oil per ounce ($1.25), and you get $0.45.
Then you add in the cost of the wick at $0.10. The other materials are a glass jar at $0.50, a warning label at $0.03, and your brand label at $0.50.
Your total raw materials cost per unit is $2.00. This is useful for calculating the total manufacturing cost. You sell each candle for the price of $8. So, you have a $6 gross margin per unit sold.
You create a first batch of 30 candles which is worth $60 plus direct labor costs.
In the first two weeks, you sell 25 candles at the standard selling price of $8.
As the first batch is running low, you manufacture a further 30. But your supplier costs have gone up, and it now costs $3 to make one candle. You then sell a further 15 candles. Using moving average cost, it doesn’t matter which batch is sold for the calculation to work.
So, the cost of goods sold breakdown for this month would look like this.
In practice, you would also add in direct labor costs, depending on wage per hour and the time it took to produce those two batches.
Don’t forget that this is gross profit, and you still need to take into account taxes and other expenses. This makes the calculations even more complicated. But don’t fret — there is a way to do this automatically.