Wednesday, July 05, 2006

COGS & SG&A

In finance, acronyms are everywhere. Analysts love acronyms as much as women love the hardest rock on Earth and Michael loves to rock every 25 minutes.

Sorry, or was it Michael learns to rock? But since he is learning to rock, perhaps we can assume he loves to rock as well. But that's not the point, the point is we are going to introduce two more acronyms to make you learn to rock as well.

The Cost of Goods Sold (COGS) refers to the direct input costs that is incurred by the company. This would include raw material cost, labour cost, energy cost, depreciation cost etc. For most types of industry, raw material cost or input cost will be the main focus in COGS. For manufacturing co.s raw material cost can be anywhere between 40-80% of COGS.

One important measure of profitability comes in the form of Gross Profit which is Sales - COGS. It measures the direct profitability of the company after all the input costs are deducted. For certain type of industry (e.g. retail), Gross Profit is as important as Operating Profit.

Selling, General and Adminstrative (SG&A) refers to the indirect costs incurred when doing business. As the name suggests, these costs would usually be sales, marketing, adminstrative, logistics (could be classfied under COGS as well though). A cost-conscious company is one that keeps its SG&A low. As a percentage of sales, SG&A varies from 10-40%.

Hence the total cost of the company would be COGS + SG&A, and whatever profits that remain would be the Operating Profit or EBIT (oh another acronym!). If a company has very low COGS + SG&A, it means that its OP margin is very high (40% or higher rocks!) and it is probably piling up cash and you should definitely dig further.

See also P&L statement
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