Proper calculation of Cost of Goods Sold (COGS) is important to brands because without understanding the cost of your goods once they have been sold, businesses wouldn’t have a clear picture of profits and losses. Maria Pearman, CPA, Principal at GHJ, sat down with Park Street University to provide a guideline of what is included in COGS, when a purchase becomes a cost of goods, and how this information can be used.
What is Included in COGS?
COGs are made up of three main components: raw materials and additives, direct labor, and manufacturing overhead.
Raw materials includes the ingredients that go into your liquid. Direct labor refers to the people that are manufacturing the product you sell and the value of their production labor. Manufacturing overhead includes things like rent and utilities, but could refer to the depreciation on your production equipment, as well.
When Does a Purchase Become a COGS?
As you spend money to buy things like grain, for example, that sits on your balance sheet as inventory. It’s not yet a COGS, it’s simply a swap of one asset (cash) for another asset (raw ingredients).
As you start the production process, the raw ingredients are going to then become a ‘Work in Progress’ or WIP. As you work through the production cycle all the way until you’ve actually bottled your product and have a finished case, it is still just a balance sheet item and has not hit your income statement as a COGS. It is only when you actually sell those goods that you can take the value and put it onto your income statement as COGS.
What are the Most Common Errors with COGS?
Pearman spoke of two main errors that she often sees on clients books. First, many clients only account for raw materials, the things that go into the liquid, when calculating cost of goods. This means they are leaving out either direct labor, manufacturing overhead, or both.
The other common error that Pearman encounters is clients expressing inventory or assets as COGS. Inventory cannot be calculated as COGS prior to the sale of a good.
How Can This Information Be Used?
COGS can be better used to understand how your brand’s profitability stacks up against industry benchmarks. It’ll help you understand if you are competing with your peers in a profitable way.
The information can also be used to evaluate your margin by SKU. Every good sold should have a particular margin associated with it and proper calculation of COGS can allow you to create some analytics that help drive proper managerial decision-making. Without accurate SKU-level data, it’s very hard to understand where you may be making money and where you may be losing money.
Here is the cleaned-up transcript, attributed to Maria Pearman, consolidated into 6 clear timestamps (MM:SS), with transcript artifacts, repetition, and broken sentences corrected while strictly adhering to the speaker’s original script and meaning:
Maria Pearman (00:10)
Hi, my name is Maria Pearman. I’m a CPA with expertise in beverage alcohol, and today we’ll be talking about proper costing of goods. Proper costing of goods is essential from a business perspective because without knowing truly how much your goods cost when you sell them, you don’t have clear guidance as to whether you’re making money—which is pretty critical to business. Today, we’re going to talk about what is included in cost of goods sold (COGS), when a purchase becomes a cost of goods, and how to use that information.
Maria Pearman (00:46)
There are three main components of expenses that are included in cost of goods sold:
- Raw Materials and Additives: The ingredients and packaging that go directly into your liquid and finished product.
- Direct Labor: The production labor and the value of time for the people who are manufacturing what you sell.
- Manufacturing Overhead: Production-related expenses such as rent, facility utilities, and depreciation on your distilling or brewing equipment.
One of the most common financial errors I see in beverage alcohol companies is accounting only for direct materials while ignoring direct labor and manufacturing overhead when calculating COGS.
Maria Pearman (01:52)
It is important to understand the accounting lifecycle of inventory purchases:
- Raw Ingredients: When you purchase raw ingredients like grain, it sits on your balance sheet as raw materials inventory. It is simply an asset swap of cash for inventory.
- Work in Process (WIP): As you begin production, those raw ingredients transition into WIP inventory on the balance sheet.
- Finished Goods: Once distilled, aged, and bottled into finished cases, the inventory remains on the balance sheet as finished goods.
Up to this point, none of these expenses have hit your income statement.
Maria Pearman (02:45)
Depending on your product, the timeline from raw materials to finished goods can range from days (for clear spirits) to years (for aged spirits). Carrying costs remain strictly on the balance sheet throughout that duration. It is only when you actually sell those goods that you take the accumulated cost value and recognize it on the income statement as Cost of Goods Sold. Another frequent accounting error I see is businesses recognizing these production costs on the income statement as COGS prior to the actual sale of the goods.
Maria Pearman (03:25)
Once you establish accurate cost of goods sold data, you can leverage it for strategic business analysis:
- Industry Benchmarking: Evaluate how your gross margins and profitability stack up against industry peers.
- SKU-Level Margin Analysis: Determine the exact profitability and gross margin for every individual SKU (e.g., gin vs. vodka vs. whiskey). Without SKU-level detail, it is impossible to identify which products drive profit and which lose money.
Maria Pearman (04:15)
A second layer of this financial data supports SKU rationalization—the process of evaluating your full product portfolio to identify high-margin winners versus low-margin losers, as well as high-volume versus low-volume sellers.
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