One of our Podcast listeners wrote us with the following question. I have chosen to answer it here so it will be easier for other readers to find.
“I own a wholesale plant nursery. I buy some inventory but much of it is grown from cuttings and seeds generated by other plants I own. How do I compute my cost of goods sold?”
This is a great question because before you can decide what price to charge your customer, you will need to know how much gross margin you will need to earn to make your business profitable. For most businesses, gross margin is product of gross sales less cost of goods sold. There are many unique factors that can be calculated into cost of goods sold, but in general, all expenses necessary to acquire or produce your product and sell it should be included.
The Allbusiness.com dictionary defines cost of goods sold as: “figure representing the cost of buying raw materials and producing finished goods. Depreciation is considered a part of this cost but is usually listed separately. Included in the direct costs are clear-cut factors such as direct factory labor as well as others that are less clear-cut, such as overhead. Cost of sales may be used as a synonym or may mean selling expenses.”
I like to think that nearly all costs that are not part of your company’s sales & general administrative costs (SG&A) should be included in cost of goods sold.
A wholesale plant nursery is really like many other manufacturing operations, with the exception that there may be a much higher percentage of spoilage of perishable items than other industries.
Obvious items that should be included in cost of goods sold for this business would include any live plants or seeds purchased, fertilizer, potting soil, containers, labels, insecticides, etc. Other businesses can think of all the items it takes to manufacture or deliver a service for their business. A staffing company for instance would include all payroll and payroll related expenses of the staff members it places. They would also include benefits and employer’s FICA / Medicare expenses for those employees placed in the field. The key is they are generating revenues for the company.
A plant nursery or manufacturing concern could have large utility costs such as electricity, water, etc. Since water goes directly into the growing of plants, and since the amount of water purchased for a nursery for other than growing plants is likely to be very small, your accountant might want to include a reasonable percentage of the cost of water into cost of goods sold. This would be no different than a soft drink bottling plant which uses water as the basis of the drink. In both cases water and perhaps a few other costs that ordinarily be overhead costs could be computed into the cost of goods sold.
Your CPA, accountant or bookkeeper may have other suggestions for computing cost of goods sold for your industry or business, so you should consult them for guidance.