Understanding Cost Of Goods Sold and How It Affects Contractor Profits
For contractors and construction businesses, knowing your numbers is crucial to success. One of the most important numbers to understand is the Cost of Goods Sold (COGS). This number directly impacts your profits and helps you make better financial decisions.
In this article, we’ll explain what COGS is, how to calculate it, and why it matters for your business.
What Is Cost of Goods Sold (COGS)?
COGS refers to the direct costs involved in producing the goods or services your business sells. For contractors, this includes expenses like:
- Materials (e.g., lumber, concrete, paint)
- Labor costs for employees and subcontractors
- Equipment rental specific to a project
Essentially, COGS represents what it costs you to complete a project or deliver a service. It does not include overhead costs like office rent, marketing, or administrative expenses.
How to Calculate COGS
The formula for calculating COGS is simple:
COGS = (Beginning Inventory + Purchases) – Ending Inventory
For contractors, this may look slightly different because of job-specific costs. Here’s an example:
- Beginning Inventory: Start with the value of materials and supplies you had at the beginning of the period.
- Purchases: Add the cost of materials, labor, and other direct expenses for your projects.
- Ending Inventory: Subtract the value of materials and supplies you have left at the end of the period.
Why COGS Matters for Contractors
- Impacts Your Profits
Your profits depend on the difference between your revenue and your costs. The lower your COGS, the higher your profits. By carefully managing your COGS, you can improve your bottom line. - Helps with Pricing
Understanding COGS allows you to set prices that ensure profitability. If your prices don’t cover your COGS, you’ll lose money. - Simplifies Tax Preparation
COGS is a deductible expense when calculating your taxable income. Accurate tracking of COGS helps with tax preparation for construction businesses, ensuring you claim all allowable deductions. - Improves Decision-Making
Knowing your COGS helps you identify areas where you can cut costs or improve efficiency. This is especially important in construction accounting, where project costs can vary widely.
Tips for Managing COGS
- Use Professional Bookkeeping Services
Bookkeeping services for contractors can help track your COGS accurately. Professionals understand construction accounting and can ensure your records are detailed and organized. - Track Job Costs Closely
Use job costing to monitor expenses for each project. This includes materials, labor, and any project-specific costs. - Negotiate with Suppliers
Building strong relationships with suppliers can help you secure better prices for materials, reducing your COGS. - Avoid Wasting Materials
Keep an eye on inventory to avoid over-purchasing or wasting materials. Implement processes to reuse leftover materials when possible. - Review COGS Regularly
Make it a habit to review your COGS at the end of each month or quarter. This helps you identify trends and address issues early.
How COGS Affects Taxes
COGS is a key part of your tax calculations. By accurately tracking your COGS, you:
- Lower your taxable income, which reduces the amount of tax you owe.
- Provide clear records to support your deductions during an audit.
If you’re unsure about how to handle this, consider using tax preparation services for construction businesses.
Final Thoughts
Understanding and managing your Cost of Goods Sold (COGS) is vital for your construction business’s financial health. Accurate COGS tracking improves profits, simplifies tax preparation, and helps you make smarter business decisions.
If you’re ready to take control of your COGS, consider partnering with TruePoint Accounting. We specialize in bookkeeping services for contractors, construction accounting, and tax preparation for construction businesses. Let us help you manage your finances so you can focus on growing your business.
