Updated: Mar 22
As a contractor, you are working on many projects, whether it is a small task or a big project, it requires months, years, or even decades to complete. Thus, meticulously tracking the cost of goods sold and keeping them separate from regular business expenses is key when it comes to measuring job profitability.
What is the Cost of Goods Sold in Construction?
Cost of Goods Sold (COGs) refers to the direct costs incurred in the production of any products and services by a company. This amount includes material cost, direct labor cost, and direct factory overheads. It excludes indirect expenses, such as phone bills, advertising, legal fee, sales, and marketing.
COGs are directly proportional to revenue, which means that when revenue increases, more resources are required to produce goods and products.
Because COGs are a cost of doing business, it is recorded as a business expense on the income statements and are often the second line, coming right after-sales revenues.
The COGs are an important metric on the financial statement as it is deducted from revenue to determine gross profit. You use the gross profit to measure your profitability and evaluate how efficient your company is in managing labor and supplies in the production process.
Cost of Goods Sold for the construction company
COGs in the construction industry are far trickier than other regular businesses so contractors or construction companies face some challenges to implementing accounting principles and standards.
More specially, any costs that are associated with the performance and completion of a project for a contractor or subcontractor during a specific period are measured as the cost of goods sold.
The financial statement of a contractor company mainly depends on the calculations of the COGs because the ultimate result of gross profit and gross loss can highly affect the entity’s financial health. Therefore, it’s a recommendation that complex projects, especially mega ones, should involve highly qualified officials and accountants in order to calculate the estimated COGs and include variable terms related to the cost of the project.
Additionally, COGs are used to calculate the gross profit margin on a specific construction project and for the whole company. Gross profit margin is determined by subtracting the cost of goods sold from total sales revenue, then dividing that amount by total sales revenues.
Constructors can use the gross profit margin as an indicator of how well a specific job or a company is managed. High gross profit margin refers to effective management at cost of goods sold and generating revenue.
How to calculate the Cost of Goods Sold for construction companies
In the construction industry, it’s advisable to break out your COGs by job so you can track job profitability and compare costs to your initial estimate for a specific project.
Calculating the cost of goods for contractors isn’t hard. First, you should figure out which indirect costs involve, add up all the project-related direct costs and the indirect costs you have identified. Remember except for overhead costs and business taxes.
Now you might know how to calculate the cost of goods sold for contractors. Except for deciding indirect costs to apply to projects, calculating COGs isn’t hard, right? Tracking your costs by the job will help you keep costs organized, and allow you to quickly determine how profitable a project is.