What Is the Significance of Cost of Sales?

Also known as the cost of goods sold, "cost of sales" is a term that is used in slightly different ways in the business world. Manufacturers use the term to identify the total cost of direct labor and materials, and the factory overhead involved in producing each unit of a good for sale. Retailers use the term to indicate the purchase price that is assigned to each item that is ultimately sold. With both applications, properly evaluating the cost of sales can make a huge difference in how the business operates and how it manages the expenses associated with selling those goods.

One of the factors that affects the cost of sales is the amount of resources that go into the process of creating and selling goods and services to buyers. For the manufacturer, this involves the cost of the production effort, especially in terms of direct labor, the cost of materials used in the creation of the goods, and the overhead costs of operating the plant in which the goods are produced. Bundled in these expenses is often the cost of maintaining a sales team to close deals with customers and arrange for the sale of those produced goods. If the cost of sales exceeds the revenue stream generated by selling the goods, this is an indication that the company will not make a profit and will eventually fail.

When the cost of sales is high, owners and managers must see where expenses can be trimmed so that the sales of the produced goods will cover all costs and allow the company to make a profit. This may involve changing suppliers for raw materials or some creative rearranging of the use of labor in the operation. It can also mean taking a closer look at the salaries and commissions provided to the sales team. If the compensation plan for the sales team drives the cost of sales over the amount that can be recouped by revenue generated by the sales, then there is a good chance that the compensation plan will be changed in order to restore some balance in company finances.

Periodically evaluating the cost of sales makes it possible to determine what must be done to adjust to current market conditions in order to protect the interests of the company. While the process is often focused on trimming expenses in order to maintain a decent level of profit, assessing the cost of sales from time to time may also indicate that by increasing the amount of resources used, the company can produce more units and take advantage of a high demand in the marketplace. When this is the case, tracking the cost of sales to make sure profit per unit produced is maintained or even slightly enhanced while these additional units are generated to meet that demand can provide valuable information in terms of scheduling labor, ordering raw materials, and in general operating the facility in the most cost-effective manner possible.