Although the cost of goods sold (COGS) is a figure that weighs significantly on companies’ financial statements (even up to 75% of revenues on an annual basis), to this day it continues to be poorly controlled. Mainly because it is not easy to do so.
Neglecting the cost of goods sold: here is what it entails
Failing to monitor this figure constantly, especially in seasonal businesses, not only prevents you from seizing the opportunities that arise from it, but also makes it impossible to assess the company’s true position, exposing it to significant risks.
Knowledge of the cost of goods sold in fact makes it possible to reconcile, on a monthly basis, the purchases-and-inventory view with the cost-of-goods-sold view, enabling opportunities that would otherwise be untapped:
- Analysis of margins by customer and product (contribution and industrial) at actual cost and no longer only at standard cost.
- Knowledge of the value chain and of the consolidated margin, net of Transfer Price policies.
- Planning processes (budget, forecast, plans) managed no longer on a cost-of-goods-sold basis but according to the (reconciled) purchases-and-inventory view.
- Closely linked to the previous point is the ability to carry out financial planning in a more meaningful way, rather than according to historical algorithms that break down the cost of goods sold into its various components.
- Analysis of variances between what was planned and what was actually recorded.
Despite this, it is common to find situations within companies that are in open contrast with what has just been described:
- The management closing process is not always reconciled with the statutory one (if not at year-end and through rather questionable balancing operations).
- The cost of goods sold is calculated at standard, and the analysis of margins by customer and product is done only according to this view, even though the actual trend may differ, both because the standard cost is not correctly maintained and because there is seasonality in the business.
- Economic planning activities are done on the margin, obtaining the cost of goods sold (COGS) as a derivative.
- Financial planning activities are carried out by assuming cost-of-goods-sold (COGS) composition logics based on historical trends.
Consequences of a failure to analyze the cost of goods sold
It is clear that such an attitude necessarily leads to a lesser knowledge of one’s own business and, consequently, to a reduced ability to react in the face of external pressures. Being able to answer these questions is something companies must be able to cope with:
- Is the statutory/management reconciliation carried out only at year-end sufficient?
- What is the real contribution/industrial margin? Are we able to break it down by customer/product?
- What is the cost of the non-absorption of labor across the various production plants?
Knowledge of the cost of goods sold (COGS), and the subsequent pursuit of the benefits mentioned above, passes through 3 different components:
- Cultural: companies do not always have the awareness of how to bring this figure under control, both from an organizational and an IT standpoint. And business models are often followed that use this COGS without actually knowing it.
- Organizational: the link between the world of operations and the world of finance is key in this type of activity. Processes must therefore be institutionalized within the company that foster this communication.
- IT: not all the tools available on the market to support the AFC area (typically linked to the CPM sector) are suitable to foster and support the planning and control activities of COGS in the full sense of the term.
Turning to Excel is not the solution
More often than not, IT projects in the CPM area, aimed at implementing the processes that involve the world of finance (closing, budgeting, forecasting, reporting, …), focus more on adapting an AS-IS model than on a preliminary BPR activity aimed at enhancing the most strategic elements for a company’s competitiveness and survival.
Certainly the topic of the cost of goods sold (COGS) is critical and must be considered central in any process in the AFC area. This is why companies must be guided in this type of choice, to avoid ending up with tools that, while doing their job well, are not capable of increasing every company’s cruising speed. Often, in fact, companies prefer not to spend on BPR activities or on the redesign of control models, and rely on good old Excel as an escape from the classic processes. Certainly an immediate saving is achieved, but the risk of losing opportunities or, in the worst case, losing competitiveness becomes increasingly concrete.
