![]() So, Should Service-Based Businesses Use COGS? The company may need to consider increasing prices or look for ways to decrease costs. If that gross profit margin is too slim, the company may run into trouble covering its other costs, such as paying rent expense and other overhead costs, paying off debt, building up an emergency fund, and giving owners a return on their investment. So, each time the company does an air conditioner repair job, they incur $850 of hard costs, generate a gross profit of $450, and have a gross profit margin of 34%. $50 in incidental materials and supplies.$200 for the technician’s wages and benefits.In evaluating its cost of sales, the company determines its costs to perform the work include: And when you use your COGS figure to calculate gross profit, you know how much excess revenue you have to cover your overhead, rent (office building or space), payroll costs (employee salaries), retirement plan contributions, and more.įor example, say Hot Spot HVAC Services typically charges a customer $1,300 to replace the compressor on an air conditioner. If you work in a service industry, understanding the COGS or cost of sales for your service company is important because it helps you determine whether you’re pricing your services appropriately. These costs incurred as expenses shouldn’t be included in the total cost of sales for a services business. Most service businesses incur some expenses regardless of whether they sell a product or service. What Expenses Aren’t Included in Cost of Goods Sold for a Service Company? Fuel costs for employees traveling to and from job sites.Incidental materials and supplies that go into completing the service.Sales commissions paid to sales representatives.Direct labor for the employee wages for people who perform the service.On December 31, 2022, they take a physical inventory count and determine there is $8,000 of inventory on hand.ĭepending on your needs, your service-based business might also include: In 2022, the company purchases an additional $11,000 of parts. Returning to our Hot Spot HVAC Services example, say the company had $10,000 of inventory in the warehouse as of December 31, 2021. You add to that figure any additional stock purchased during the year, then subtract any inventory remaining at year-end. Form 8027: Your Guide to Reporting Tip Incomeīeginning Inventory + Purchases – Ending Inventory = Cost of Goods Soldīeginning inventory is the ending inventory from the prior year’s financial statements.FreshBooks’ Double-Entry Accounting Glossary.Understanding Cost of Goods Sold for Services.These businesses may want to track all of the direct costs of performing services for customers and break out the cost of sales on their income statement. Plumbers, electricians, and other tradespeople.Other businesses might keep inventory on hand or purchase substantial parts and materials while performing services. These companies simply report direct labor costs and other costs of doing business as operating expenses on the income statement. “Pure” service companies that don’t use inventory and parts to deliver their services may not track cost of sales or cost of revenue on the company’s income statement.Įxamples of these types of business include: Most service-based businesses that do refer to it as “cost of sales” (COS) or “cost of revenues.” Service Companies That Use Cost of Goods Sold So, if it makes sense for your business, you can opt to track cost of goods sold. So, Hot Spot HVAC Services does keep track of inventory and show COGS on its financial statements. However, they also keep an inventory of more expensive parts on hand so that technicians don’t have to make time-consuming trips to a local supply depot or leave customers hanging when a crucial part is out of stock. The company writes off many incidental materials and supplies, such as coils, ducts, and vents. On the other hand, Hot Spot HVAC Services is an HVAC company that installs and repairs air conditioners and furnaces. So the firm doesn’t account for inventory or cost of goods sold and instead deducts those items as materials and supplies in the year they pay for them. These items are inexpensive, and it wouldn’t be worth their time to keep track of each piece of paper or pen. They don’t sell any products, but preparing for a trial typically involves a lot of printer paper, legal pads, pens, sticky notes, and coffee. Matlock & Associates is a law firm representing clients accused of criminal activity. ![]() Let’s consider 2 fictional companies and whether it would make sense to account for cost of goods sold. However, it might make sense in some cases. Service-based businesses generally aren’t required to account for inventories and cost of goods sold. Cost of Goods Sold for a Service-Based Business
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