How to Effectively Use Costs of Goods Sold – COGS

Why direct job-costs for service companies should be classified as COGS

And not overhead and administrative expense

In this article, we discuss why service companies, including contractors, should us Cost of Goods Sold. Even though your main business model is service, not retail. You will see why having direct expenses, the costs associated with each job…not administrative costs … in the Revenue section of you company’s P&L statement. You will see that this is a good practice.

What is Cost Of Goods Sold?

In accounting for a manufacturer, the raw materials that go into making the product you want to sell are tracked in an inventory account. When used in the manufacturing process, the bookkeeper records the items taken from inventory and puts them into the Revenue section as COGS.

Direct labor, labor burden, insurances, & other job expenses belong here

And the cost of the labor costs used to the manufacturer the item also get recorded in the COGS section. Same with a portion of freight to get the raw materials into the plant. I think you get the idea, Accounting for manufacturing gets a little more complex but this gives you a high-level overview of COGS.

Cost of Service Sold

For service companies, including contracting businesses, the accountant can track your direct job expenses in the COGS section of your Profit & Loss Revenue section. This gives a better picture of your job profitability.

Are your quotes covering all direct expenses associated with each job? By tracking your costs in the revenue COGS section, you will be able to see. Your job expenses will be separate from the administrative expenses.

As you can see in the second spreadsheet, this sample contractor made a respectable 28% in Gross Margin. Will it be enough to have a positive net margin? That depends on this company’s administrative & overhead expenses. Office salaries, non-job related expense, rent, utilities, professional services.

The point of this is not about Net Income but rather whether or not you are charging your customers enough to cover your job costs. This includes the cost of labor wages, and the labor burden.

Workers compensation insurance. Work truck fuel & insurance burden. Liability insurance burden. Overtime wages plus regular wages. Employers portion of Social Security and Medicare.

These have to be factored into the cost of the job to get an accurate picture of your bidding system. Without including these expenses in this part of the P&L, you’re operating in the dark.

What are industry benchmarks for Gross & Net margins?

In this chart, these are some of the industry benchmarks for small contracting businesses.

COGS for service businesses conclusion

Accounting for contractors and other service type business should be tracking the actual job costs. If you put everything in the P&L Expense section, you are missing important information for the best decision making as an owner.

If you are using QuickBooks Online, Plus or Advance subscriptions, you can start using the job tracking feature called Projects. With this tool, you can create a Project for a customer, assign labor, materials, and other costs to the project and

It does take extra work to set up your accounting system to track these in COGS but in the end, you get better picture of your bidding strategy. You should talk to C & M Bookkeeping about using QuickBooks Online to track job related expenses. And to make sure they accurately affect you Gross Profit for better management decisions.

If you would like to schedule a free 1/2-hour accounting consultation, fill out the form in the blue box to the right of this article. Thanks for reading and Charley, Manny, and our staff look forward to helping your company grow and reach new heights.