Inventory is the number one consumer of cash on the balance sheet. So effectively predicting your cost, is an essential part of cash management. A rise in cost of goods sold cause’s margins to diminish. Rightly predicting cost of goods sold starts with accurately predicting sales. Once sales have been predicted, then we use sales numbers to effectively predict what our inventory level should be (i.e. quantity).

1. How to
Effectively
Predict Cost
of Goods Sold

2. You have heard of the
TERMINOLOGY COST OF
GOODS SOLD. But what
exactly is it?

5. Here is HOW IT WORKS
When a merchandise
business buys
products for resale it
is an inventory asset
When a merchandise
business sells the
product, it becomes cost
of goods sold

6. Effectively predicting cost of goods sold
A rise in cost of goods sold cause’s
margins to diminish. Rightly
predicting cost of goods sold starts
with accurately predicting sales

7. Inventory/ cost of goods sold cost is
split into 3 parts
There are 3 components to inventory cost
Direct materials
Direct Labor
Manufacturing
overhead

8. Direct Material
The price of your materials are based on 2 main factors
The cost of
producing your
materials
The quantity
you buy

9. Factors affecting price
The following factors affect the cost of your materials
Industry value chain
cost * Markup
Markup for scarcity (if
no substitutes
available) or
Markdown for
surpluses
Markup for inflation

10. Industry Value Chain Cost
Consists of the resource owners cost * Markup
&
Markup for the number of businesses in the industry
value chain before the material gets to you

11. Industry Value Chain
Resource owner's cost * Resource owner's markup * Markup
for number of touch points in your industry value chain
Each business that handles the material adds their own
markup
Resource owners cost and conversion agents costs totals your
industry value chain cost

12. Markup for scarcity or Markdown for
surpluses
Some downsides of being in an industry when you have low bargaining power are
Cost of goods sold
will be higher
Shortage of
supplies
When this is the case the cost of your goods will be higher. In estimating your material cost, include a markup

13. Consideration for availability of
substitutes
When cheaper substitutes exist that
could meet the same purpose, the
cost of buying the materials you
need may be less

14. Markup for inflation
Industry value chain cost * Markup for scarcity or
Markdown for surpluses * Markup for inflation
Taking inflation into consideration, the price of the goods
we sell can be calculated as follows

15. Direct Materials: What determines how much
material we buy?
Quantity = Sales forecast (subject to market supply & business
capacity) + quantity at which economies of scale occur
The equation for quantity purchased is as follows

16. Direct material summary
Direct Material Cost = Quantity * Price
Quantity = Sales forecast (subject to market supply & business
capacity) + quantity at which economies of scale occur
Price = Industry value chain cost * markup for scarcity or
markdown for surplus* markup for inflation
Direct Material Cost = (Sales forecast (subject to market supply &
business capacity) + quantity at which economies of scale occur)
* (Industry value chain cost * markup for scarcity or markdown
for surplus* markup for inflation)

17. Direct Labor
Direct Labor = Number of hours needed * Price
per hour
The cost of direct labor can be calculated as follows

18. Number of hours needed for direct labor
Direct labor hours = Number of hours needed to
bring sales forecast to reality * percentage
discount for skilled labor set
The more experienced your labor force, the less hours
you should need to get the same output

19. Price per hour
Price per hour = Average market price * premium
for skill sets with limited supply
Moving your business to a location with a wide pull of
candidates will drastically lower your total labor cost

20. Direct labor summary
Direct Labor = Number of hours needed * Price per
hour
Direct labor hours = Number of hours needed to
bring sales forecast to reality * percentage
discount for skilled labor set
Price per hour = Average market price * premium
for skill sets with limited supply
Direct labor = (Number of hours needed to bring sales
forecast to reality * percentage discount for skilled labor set)
* (Average market price * premium for skill sets with limited
supply)

21. Overhead
Overhead cost =Activity level * buffer percentage
* cost per unit
Your overhead should allow for the uncertainties in the market place.
You do this by including a buffer in the activity level as follows

22. Conclusion
As inventory is the number one line item that eats cash, it is essential to
minimize cost. Knowing the factor that influence the prices you pay, can
help you make smarter choices
Direct materials
Direct Labor
Overhead

23. Each of these components have many factors
that affect their estimation while developing
your budget. The whole point of going through
the equations discussed is not to achieve
perfection but to help you think beyond your
normal
Read full article:
www.mybusinesskpi.com/CostOfGoodsSold.html

24. Predictive Accounting with KPIs: A More
Predictable, Less Stressful Way to Run Your
Business.
Phone: (417) 812-5945
Address: 1700 S Spring Street, Springfield, IL 62703
Email: evelyn@mybusinessskpicoach.com
www.mybusinesskpi.com
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