Cost of Goods: The Closed Loop (Tradecraft)

This article is about the closed loop system known as Cost of Goods Sold. Anyone who's not a buyer for a game store is not likely to understand the importance of this data, which often gets sloppy when entered into point of sale systems by harried game store staff. This is written with my staff in mind, but it might be useful for everyone who works at a game store. Feel free to share, of course.

Cost of Goods Sold is the term used to track inventory value as it goes through your store. As the name states, it's the cost of the goods the store pays from its suppliers, with the difference between the Cost of Goods and the price you sell it for being the gross profit. It's gross because it doesn't include the many expenses, like your paycheck, that reduce the slightly less than half of gross profit down to about a 5-10% net profit. For example, a $100 board game might have a cost of goods of $54 and after all the expenses of the business are taken out, may only have a net profit of $5-10. If the store is lucky.

Product is not only the lifeblood of the business, but too little inventory can lead to a catastrophic death spiral, while too much inventory can lead to an enormous end of year tax bill or outright business failure, as all the money is tied up in inventory. No new money is poured into an inventory budget, so for new product to come into the store, old ones have to be sold to produce a purchasing budget surplus. Even if your store is doing great, you might be putting older product on sale just to create this necessary surplus. There is no input without output.

Let's take a look at the full cycle of Cost of Goods, to better understand its importance. This will include looking at adding items to the system, receiving new product, and finally, Open to Buy, which which is what your store buyer is using to determine how much money is available to spend on more product. I'm using my POS system (Lightspeed Onsite) in the examples, because that's what I've got, but it worked the same way when I had Microsoft RMS and I'm guessing it's not much different for other full featured systems. 

The first time a store encounters cost of goods is on a product invoice. 

The Unit Price here is the Cost of Goods. It doesn't include things like shipping, COD costs or other "not product" cost of good expenses.

This unit price gets entered into the POS system Purchase Order, hopefully accurately. As stores tend to order product from a variety of distributors, it's important the actual price for this particular order gets entered properly onto the Purchase Order correctly, since it cascades throughout the system.

Purchase Order where the cost is grabbed from the product record, but can be overwritten if necessary

Most POS systems have a place for the Cost of Goods on the product record. It's important that the record is accurately updated and bad data isn't allowed onto the Purchase Order.  If the Cost is not entered correctly, that incorrect data cascades through the POS all the way to the purchasing budget, which we'll get to in a moment. 

Product record, where the cost is copied over to the Purchase Order when a PO is auto generated

At this point, most game store clerks stop worrying about Cost of Goods (Cost), and if they entered everything correctly on the produce record and the purchase order, everything is in good shape. But where does the data go from there?

The Cost of Goods is collected from end of day reports that track sales, noting the cost paid for each item sold. This report takes that hopefully accurate Cost of Goods number and provides it to the buyer.

This Cost of Goods number is then entered into an Open to Buy spreadsheet or hopefully some similar tracking mechanism. To be honest, most buyers don't have an Open to Buy tracker, but let's assume they're using something to track Cost of Goods so they know how much they have to spend.

The Open to Buy spreadsheet (or whatever) tells the buyer they now have $2,027.32 to add to their purchasing budget to buy product. If that number is off,  the buyer may not spend enough and is now under budget and losing sales. If the buyer spends too much, they are over budget, and not only will profitability suffer, but the business will incur taxes on the difference between the previous year's inventory value and the current year (it's good to check the difference and adjust at least quarterly). 

Open to Buy: Available = Previous Available + Cost of Goods - Purchases

So how accurate is all this? Not very. The true Cost of Goods, the only one that really matters, is in the accounting system. Last year our Cost of Goods in the POS was 53%, while Cost of Goods in the accounting system was 56%. Some of that 3% difference are Cost of Goods that are not inventory, like shipping and finance charges, things you definitely don't want polluting your POS system. That's maybe 1% of the variance. Most of that slop is bad POS bookkeeping. The most important thing for me is making sure my purchasing budget is balanced at the end of the year to avoid excess taxes.