The cost of goods sold item indicates the cost to produce the goods sold and includes the raw materials and labor costs to create the finished product. The cost of goods sold is often a substantial line item for traditional manufacturers, wholesalers, and retailers so the method used to determine this expense can have a dramatic effect on the company's bottom line. Switching from a LIFO (last-in, first-out) to a FIFO (first-in, first-out) inventory valuation system in an inflationary period can boost earnings temporarily as inventory tagged with older, lower prices is matched up with sales. Companies have some discretion on the accounting method used to determine the cost of inventory sold, and any changes to the methods must be disclosed in the notes accompanying the financial statements.
Subtracting the cost of goods sold from the net sales revenue produces gross income (or gross profit). This is the first income step and indicates the profitability before operating, financial, and tax expenses are considered. The nature and efficiency of the product's manufacturing cycle will greatly affect the gross income.
Continue to Step 4 »
