Energy Cost of Goods Sold

An important measure made possible by energy analytics

Energy COGS: Energy Cost of Goods Sold

Electricity cost is the second largest expense after labor and is hard to reduce. Your electricity bills are typically buried on a Profit and Loss Statement in Operating Expenses and difficult to understand. Elevating electricity cost to COGS (or Cost of Goods Sold) exposes the cost in the context of what you make. Electricity Cost of Goods (or Energy COGS) is a powerful measure made possible by energy analytics. It moves, stores and facilitates economic and financial metrics to help you reduce the burden.

What is Energy Analytics?

Energy analytics software, such as, PredictEnergy® can provide the tools to look at your organization's performance. A key outcome is the ability to capture energy cost above the gross margin line and implement new management practices and incentives to drive down those costs.

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Cost Off Goods Sold: One Of Three Types Of Expenses

energy cogs is an important measure made possible by energy analytics

There are three overall categories of expenses in the accounting world: cost of goods sold, operating expenses, and extraordinary expenses. COGS is the direct cost of the products and services your business sells. The cost of raw materials and labor is a direct cost and is usually considered a controllable cost. Significant business attention and resources focus on these costs to increase gross margin.

The cost of insurance, fuel, and maintenance for the trucks used to carry the bricks and mortar are indirect costs. While these costs are part of the product produced and are incurred in the process of generating revenues, they cannot be identified as belonging to a specific job or product.

These indirect costs, which also include items such as heat, power, insurance and rent are also known as operating expenses or overhead. Operating expenses are listed under expenses in the profit and loss statement. Only the direct cost of the product is included in the calculation of cost of goods sold and margin. The COGS vary directly with the volume of goods produced and sold; for example, each sale adds to cost of sales. Operating expenses, on the other hand, are relatively fixed. The business will pay the same amount of rent and insurance whether 10 items or 100 items are sold.

Understanding the Standard Financial Statment

COGS and operating expenses are shown in separate sections of the profit and loss report. The statement below shows revenues, followed by cost of goods sold. COGS are subtracted from revenues to produce gross margin, or gross profit. Then, expenses are summarized, totaled, and subtracted from gross margin to calculate net income from operations. Finally, extraordinary items —like the gain or loss on a sale of fixed assets — are added or subtracted from net operating income to yield net income.

The standard format for an income statement is as follows: The cost of insurance, fuel, and maintenance for the trucks used to carry the bricks and mortar are indirect costs. While these costs are part of the product and are incurred in the process of generating revenues. They cannot be identified as belonging to a specific job or product. These indirect costs are also known as operating expenses or overhead. Operating expenses are listed under expenses in the profit and loss statement. Only the direct cost of the product is included in the calculation of cost of goods sold and margin.

ecogs on Energy COGS reduces energy costs

The COGS vary directly with the volume of goods produced and sold; for example, each sale adds to cost of sales. Operating expenses, on the other hand, are relatively fixed. The business will pay the same amount of rent and insurance whether 10 items or 100 items are sold.

The Importance of Energy COGS (Energy Cost of Goods Sold)

As stated earlier, historically, utility expenses such as electricity and heat are listed as operating expenses.  Furthermore, COGS varies directly with the volume of goods produced and sold.

However, the cost of electricity can also vary directly with the volume of goods produced and sold and be one of the top 3 costs a business incurs, along with labor and material costs. The idea was basically since a single electricity bill was received every month, it needed to be applied across the whole of the operation.  Not until the advent of technologies, such as PredictEnergy®, did the ability to allocate costs of electricity directly attributed to the production of a good or service become available.  Thus, the creation of the notion of energy cost of goods (COGS), or energy COGS.

PredictEnergy® to the Rescue!

Energy COGS is simply the cost of electricity incurred to produce, move, and store each unit of goods and varies with the volume of production.  Therefore, it can easily be argued that it should be a component of COGs, if there were a means to measure and allocate it on a per unit basis.

PredictEnergy® provides the ability to perform this function.  A number of our clients have implemented PredictEnergy® in their businesses to know the energy cost on a per unit basis to produce, move, and store each individual SKU number.  Further, they have implemented management practices by creating energy cost KPIs (Key Performance Indicators) for applicable team members and have tied incentive pay to those KPIs.

By moving the cost of electricity above the gross margin line, businesses now have a more accurate and actionable picture of the cost of producing their goods, and its impact on gross margin. It is a standard management principle to control COGS as tightly as possible in order to maximize gross margin.  Typical management controls include enhanced and detailed reporting. As well as the creation of metrics to measure COGS performance. The creation of incentives for managers and floor supervisors to control waste and increase production.  Energy COGS gives you the ability to elevate electricity cost to this same level of scrutiny.

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