The cost of making a sale

Stock is an asset until it is sold

Morrow's stockroom holds $4,000 of chains, tubes, brake pads and cables on January 1. Buying a box of chains from the supplier costs the business nothing yet, in the Scorecard's sense. Fitting one to a customer's bike does.

Inventory is an asset while the goods are held, waiting to be sold or used in production. It sits on the Snapshot (balance sheet) at cost. When a unit sells, its cost becomes cost of goods sold on the Scorecard (income statement), COGS for short. A service business calls the equivalent line cost of revenue or cost of services; the label follows the business. Buying parts moves cash into stock; selling moves stock into expense. Two lenses, one bridge, and the reflex for this unit: what is the bridge?

Worked example: a year in the stockroom

During the year Morrow buys $10,000 of parts and ends with $3,000 on the shelves. The rollforward is ending inventory = beginning inventory + purchases − COGS − other reductions. With no write-downs or shrinkage, COGS is 4,000 + 10,000 − 3,000 = $11,000.

Sales for the year are $18,000. Gross profit is 18,000 − 11,000 = $7,000, and gross margin is 7,000 ÷ 18,000 = 38.9%. Gross margin is the first bridge from revenue to profit: what is left after the direct cost of what was sold, before rent, the front desk and everything else.

Nor is every fall in inventory a sale. Write-downs, shrinkage and disposals reduce inventory without producing revenue. They belong in the "other reductions" term, and they still reduce profit.

What goes into the cost of a unit

For a manufacturer, the cost of a unit includes direct materials, direct labor and a fair share of manufacturing overhead, such as factory rent and the depreciation of factory machines. Product costs wait in inventory until the unit is sold. Selling and administrative costs are period costs, expensed when they happen, whether or not anything sold. The rules decide which is which, not a wish for a better gross margin.