Some cost estimates go directly along with the sales forecast, because these are costs that you don’t incur unless you make the sale. If you haven’t already, you might want to read the Understanding Fixed and Variable Costs and Burn Rate, section, with some important definitions. The sidebar here will help too.

So I assume you already have your sales forecast. One of the first things you do with a spending budget is figure out how much it costs you to deliver what you’re selling. As I explained in that previous section, this is cost of sales, sometimes called cost of goods sold (COGS) or direct costs, and traditionally means the costs of materials and production of the goods a business sells. In accounting, cost of sales belongs in the month in which the goods or services are actually sold, regardless of when they were purchased or produced.

A Word About Words: Don’t Confuse Costs and Expenses
Stick with the way the accountants and financial analysts deal with cost of sales. You’ll get into trouble if you don’t. You want your definition to be the same as what theirs to avoid any misunderstandings.That means cost of sales, also called direct costs, direct cost of sales, or costs of goods sold, is the money it costs you to buy or produce the goods you sell or to deliver the services you sell. Please don’t confuse this with sales and marketing expenses. Travel, meals, commissions, credit card merchant fees, and such are sales expenses, not cost of sales.

Confusing, yes, but we can’t help it. That’s the way these terms are used. You don’t want to make your own meanings, even if they’re logical, because if you need to produce more formal financial projections later on, you need your meanings to match what people expect.

For a manufacturing company, this refers to materials, labor, and factory overhead. For a retail shop, it would be what the store pays to buy the goods that it sells to its customers. For a consulting company, the cost of sales would be the remuneration paid to the consultants plus costs of research, phocopying, and production of reports and presentations.

If you projected sales in units for your sales forecast, then it should be fairly easy (for most businesses) to figure out what each unit costs you. Then you can multiply that per-unit amount by the units to estimate the costs associated with exactly that month’s worth of sales, which is the point. See the illustration below.

If you just project sales by the total amount, then try to estimate the related costs and — at least as much as you can — keep the costs in these cases as much as you can in the same month as the related sales. Don’t go crazy with it, but try.

Sample Cost of Sales

In this sample, there is a unit cost for each of the items the store sells,so you multiply the units from the sales forecast times the per-unit cost to automatically calculate the direct costs of sales.
Tim BerryTim Berry

Tim Berry is the founder and chairman of Palo Alto Software and Follow him on Twitter @Timberry.