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Understanding COGS in Construction for Financial Success

Updated: Apr 1

Cost of Goods Sold, or COGS, is one of the most important factors in a building company's financial health. COGS is an important part of accounting because it affects your income statements, your tax obligations, and your gains in the end.

Understanding COGS is the first step toward efficient cost management. In construction, COGS stands for the direct costs of making the goods that your business sells. This includes things like raw materials, labor costs, and direct factory overhead costs.

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Types of Costs Included in COGS:

COGS in the construction industry includes all the costs that are closely tied to making and delivering goods or services. These costs typically include:

Raw materials: The cost of things like wood, concrete, steel, plumbing tools, electrical parts, and other things that are needed to build.

Direct labor: The pay and benefits paid to skilled tradespeople, project managers, and laborers who work directly on the building.

Direct Spending: Costs that are directly tied to a project, such as fees for subcontractors, renting tools, getting permits and licenses, etc.

Example of COGS in Construction:

To illustrate COGS, let's consider a scenario. A construction company is building a residential property. The cost of goods sold (COGS) for this project would include the cost of materials like bricks, cement, electrical wiring, and plumbing fixtures, as well as the cost of the building crew's direct labor. These costs are important for figuring out the overall COGS and figuring out how profitable the job is.

Different Accounting Methods for COGS:

In the construction industry, different accounting methods can be used to calculate COGS. The two common methods are:

Job Costing: This method involves tracking costs on a per-project basis. It gives direct costs (like materials, labor, and direct spending) to specific projects, which makes it possible to correctly calculate project costs and analyze their profitability.

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Percentage of Completion: This method takes into account income and expenses based on how much of the job is done. It lets income and cost of goods sold (COGS) be recognized in proportion to how far along the project is. This gives a more accurate picture of how well the business is doing financially.

Limitations of COGS

While COGS is a valuable financial metric, it does have certain limitations to consider:

Excludes Indirect Costs: COGS only takes into account direct costs. It doesn't take into account indirect costs like general overhead costs (like utilities, rent, and insurance) that are important for running a business but aren't directly tied to specific projects.

Inventory Valuation: When figuring out COGS, you have to take away the end inventory value. It can be hard to figure out the exact value of inventory, especially when it comes to building supplies and projects that are still going on.

Effects of Seasonality: The cost of goods sold (COGS) can be affected by changes in the prices of products and the number of workers available. This means that calculations need to be changed.

The Importance of Effective COGS Calculation

When it comes to project costing for contractors, the accurate calculation of COGS can be the difference between a profitable project and a financial disaster. By tracking your costs and calculating your COGS, you can ensure you are pricing your services correctly and not underestimating your project expenses.

Steps to Calculate COGS in Construction

So, how do construction business owners go about calculating their COGS?

Here are the steps:

Identify Direct Costs: These are the costs that can be linked directly to a certain project. They include the costs of materials, direct labor, and direct spending.

Add Overhead Costs: These are secondary costs that can't be tied to a specific project but are still needed for your business to run. These could include utilities, rent, insurance, and salaries of non-project staff.

Subtract Closing Inventory: At the end of the financial time, if you have any materials left over, you take them out of your total costs to figure out COGS.

This might sound complicated, but don't worry! That's where CCA comes in.

How CCA Can Help

At CCA, we specialize in providing bookkeeping services for construction businesses. We know how complicated construction cost accounting can be and can help you keep track of your prices and figure out your COGS.

With our help, you can get the most out of your building costs, boost your profit margins, and protect the financial health of your business. We teach construction companies how to calculate COGS so they can focus on what they do best, which is building and making.

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