COGS for Physical Goods

icon of a manufacturing plant

Cost of goods sold (COGS) refers to the direct costs attributed to the production and sale of a product or service. COGS differs from operating expenses (OpEx), like marketing and administrative costs, in that OpEx includes expenditures that are not directly tied to the delivery of the product or service. COGS is an important metric because it is subtracted from total revenue to determine your gross profit.

Defining the COGS for physical products is critical, not only for the calculation of gross revenue, but also for predicting inventory levels, cash flow and more. This section of the model is focused on the variables that influence the landed cost of physical goods.

To calculate the landed cost of each product unit, start by defining your tooling costs across all product tiers. Tooling costs are the expenses associated with the design, development, and fabrication of implements, molds, dyes, and fixtures used in manufacturing. Whether you manufacture each item yourself or outsource to a factory overseas, you are likely to incur an annual re-tooling expense as you iterate on the design and specifications of your product.

Set Tooling Costs

Set the Molds / Tooling Costs per year for the next five years. The next row allows you to either set the month in the year (1 through 12) when you incur the tooling expense. If you want to spread this cost across all 12 months of the year, enter zero in this row.

COGS Assumptions for Physical Goods

The next section breaks down COGS for each tier you offer. For each product tier enter the landed cost in years 1 through 5. The landed cost in this model is the total cost of each unit after it has been shipped to directly to a warehouse or fulfillment center or directly to your customers (if using a drop-shipping method). The landed cost should include all associated expenses like shipping, customs, duties, insurance, and other related fees:

Landed cost = unit cost of product + shipping/freight + customs + insurance

If your manufactured goods are shipped to a warehouse before being distributed to customers (i.e via FBA or another operator), do not include those "last-mile" or fulfillment costs in the landed costs. Fulfillment costs are part of your operating costs and are handled in another section.

In the next row, you will see the model references the retail price of each unit and calculates the margin on the retail price and the wholesale price (if applicable). To change the retail price, go back to Pricing: Physical Goods.

Set Manufacturing and Inventory Assumptions

The next several assumptions are critical in defining your manufacturing cadence.

Starting Inventory

Start by setting your current dollar value of your inventory. This is the landed cost per unit multiplied by the number of units currently in your inventory. For example, if you have 5000 units sitting in your warehouse and your landed cost per unit is $4, your starting inventory value is $20,000 (5000 x $4 = $20,000). If you are starting out and have no inventory, set this number to $0.

Manufacturing Lead Time

Set the manufacturing lead time in months. For example, enter 2 if it takes the manufacturer 2 months to deliver a batch of products from the date an order is placed to the date it arrives at your warehouse (or to your customers, if using a drop-shipping approach).

Months of Inventory to Batch

Set the number of months of inventory to batch per manufacturing run. Think of this as the desired number of months it will take before a single batch of manufactured goods is sold out (based on predicted sales). This is a critical assumption because it drives the number of units you will purchase per manufacturing run, which often has a significant impact on cash flow. Increasing the number of months worth of inventory you purchase per batch, increases the amount of cash you need to place each order. If the model predicts a high financing need, try reducing the number of months of inventory to batch per manufacturing run. This will make the size of each batch smaller and, thus, less capital intensive.

Inventory / Manufacturing Approach

There are three inventory or manufacturing approach options:

  1. Batched: Where a set quantity (or "batch") of units are ordered, produced by the manufacturer, and delivered to a warehouse or fulfillment center where they are distributed to customers. The model will forecast when and how many units to order based on projected sales over a specified number of months (see previous assumption field) so you consistently have enough inventory to meet customer demand.

  2. Just-in-time: Where the quantity of units produced by the manufacturer aligns closely with customer demand such that you hold little, if any, inventory. This approach is more common for B2B companies.

  3. Drop Ship: Where customer orders are forwarded to the manufacturer (or other third-party supplier) who then ships the product directly to the customer. This approach assumes zero inventory holdings.

Months of Extra Inventory Buffer

Set a number of additional months of inventory to batch per manufacturing run. This field allows you to tweak the "Months of Inventory to Batch" variable. Set this number to zero if you don't need a buffer.

Inventory Prediction Engine - Batched Inventory / Manufacturing Only

After adjusting the assumptions above, the model will show four calculated outcomes:

  1. Number of months your start inventory is projected to last: Based on your sales forecast, this is the number of months your inventory will last before running out. If you are starting with no inventory, this value will be zero.

  2. Suggested month to make first inventory purchase: Based on your sales forecast, starting inventory value, and manufacturing lead time, this is the month in which you should place your first inventory purchase (from the starting month of the forecast) to ensure you have sufficient inventory to meet customer demand.

  3. Suggested number of units to be manufactured in first batch: Based on your sales forecast and the months of inventory per batch, this is the exact quantity you should order in your first inventory purchase.

  4. Cost of suggested first manufacturing batch: This is the product of #3 above and the landed cost.

These outcomes serve as the starting point for your manufacturing cadence.

Human Override

You might find that one or more of the predicted outcomes above do not align well with the circumstances or constraints of your situation. For example, the suggested number of units in your first batch may not meet the minimum order requirement set by your manufacturer. You may also find that the cost of the suggested first batch exceeds your current cash on hand.

To override the model's suggestions, click the checkbox next to "Check This Box to Override the Prediction Engine". This allows you to enter the month you would like to make your first inventory purchase and the number of units to be manufactured in your first inventory batch. You can enter these values based on the predicted outcomes calculated above.

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Repeat the steps above for other active tiers and continue to the Cash Management Assumptions. Or head back to the Guidance page.