Amazon businesses can grow quickly, but what does your bottom line look like?
As Amazon seller accountants, we regularly see this problem of fast-growing Amazon businesses unsure of whether or not they are profitable.
The core question is, am I making a loss? Well, the solution to this answer is calculating your Cost of Goods Sold (COGS) or cost of sales. Knowing this and getting it right means you know exactly your profit and Return on investment (ROI). If you don’t know this then you could be making a loss without even realising it!
Below, we look at the importance of COGS on Amazon and how to successfully calculate it to make sure your business is profitable.
A Tale of Two Amazon Businesses
Take a minute to look at each of the two example Amazon businesses, showing revenue, COGS, stock and profit:
- Business 1 has a steady increase in revenue but its bouncing between profit and loss and has spikes in COGS.
- Business 2 has a steady increase in revenue as well but it has a steady flow of COGS. You can even clearly see, that every month they are profitable. There is no question they are profitable and you don’t even need to investigate further.
Which business would you prefer to be? We hope you answered number two, with steady revenue and profit.
You may have seen this coming, but this is actually the same business with exactly the same figures. The one key difference is one is accounting for COGS in the correct way. The other is recording purchases of product as cost of sales as soon as it hits their bank.
So, what are COGS Exactly?
There are some very accountancy-based definitions out there but in a nutshell, COGS (Cost of Goods Sold) are the landed cost of each product sold. That means if you still have an item, it is not yet a cost of goods sold, it is inventory (more on that later).
To calculate COGS, you need to know what it is made up of:
- The amount paid for the actual product
- Irrecoverable tax on import of product
- Duties and tariffs
- Cost to assemble the product
- Shipping from the factory to the place of distribution
So, for example, we bought 100 blow up canoes from China. We need to calculate our cost of goods for each canoe. Our costs were:
So, at the moment we have NO cost of goods sold on the profit and loss and we have £1,460 worth of Inventory (which sits on the balance sheet).
It’s vital understand that COGS is solely about landed costs for each piece of inventory and is not associated with more general overhead expenses for your business (such as staff, office space etc.)
Cost of Goods per SKU
If you have multiple products/SKUs then you would need to do this for each SKU to work out the average landed cost per each SKU.
That means you can then calculate the gross profit for each item and then work out an overall gross margin.
This is really useful for determining which of your products are the most profitable, and thus which you should prioritise for the health of your business.
It may also be a reason to spend money on these SKUs on Amazon’s advertising platform, a good way to gain visibility on individual products.
Caclulating Value of Stock on Amazon
Another key difference seen on the Amazon Business 2 graph is that they have a stock line, which is the value of the items they have yet to sell.
To calculate the value of your stock you can do the following simple equation:
Units of each SKU x Calculated Cost of Goods per SKU = Stock Value
So, using the earlier example if we had 90 blow up canoes left (units of each SKU) we would multiply that by £14.60 (COGS per SKU) to get a total stock value of £1,314.
Knowing the value of your stock means you understand the value of your business better and don’t panic if the cashflow gets a little tight.
As long as the product retains its saleability, you should recognise (and calculate) the value of having stock in your business.
Article: Can you sell on Amazon without registering for VAT? Read more…
So what is Gross profit?
Gross profit is the key figure to understanding the health of your Amazon business.
Gross profit can be calculated using a simple equation:
Total Sales – COGS = Gross Profit
So, if you sold 10 blow up canoes in January for £26.60 each you would have revenue of £266 (Total Sales), you would subtract (£14.60 x10) £146 (Cost of goods) sold. As a result your gross profit will be £120.
The key aspect of this is as that this equation ignores any other overheads which you will incur if you made sales or not. In this way we are looking at the profitability of the products rather than the wider business.
Maintain a healthy gross profit margin and your business will be able to grow sustainably. Understanding this metric is key to avoiding cash flow issues caused by inaccurate bookkeeping, which is a common mistake made by Amazon sellers.
The Importance of COGS for your Amazon Business
COGS calculations are really important for businesses that sell products on Amazon or any other marketplace such as Shopify, eBay or Etsy. This is because you will most likely spending all the cash you generate on more stock.
If you do invest profits into stock and you don’t have a clear idea of your COGS, you will assume you are in a loss-making position all the time when actually you are investing sensibly into further stock.
However, in some cases people assume they are making a profit and when we calculate their COGS they are in fact making a loss due to not knowing their Amazon Selling fees or FBA fees.
COGS is, therefore a vital part of the accounting process you need to understand to continue running a successful Amazon FBA or FBM business.