Energy COGS

Energy COGS: An Important Measure Made Possible by Energy Analytics

Electricity Cost of Goods or Energy COGS as being an important measure made possible by energy analytics. Energy analytics, such as HelioPower’s PredictEnergy software, and associated practices provide the methods to look at your business’ performance in new and unique ways.  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 these energy cost.

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Cost Off Goods Sold: One Of Three Types Of Expenses

In the accounting world, there are three overall categories of expenses: cost of goods sold, operating expenses, and extraordinary expenses. Cost of goods sold (COGS) is the direct cost of the products and services your business sells. COGS can be directly identified in the end product. For a manufacturer, the cost of raw materials and labor is a direct cost and is usually considered a controllable cost. Significant business attention and resources are focused on these costs in order to increase gross margin. Purchasing departments are created and team incentives are paid on the ability to reduce COGs and 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 varies 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. First, the statement shows revenues, followed by cost of goods sold.  COGS is subtracted from revenues to produce gross margin, or gross profit in the below example. Expenses are then summarized, totaled, and subtracted from gross margin to calculate net income from operations. Finally, extraordinary items — such as 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 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 varies 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.

ecogs on Energy COGS reduces energy costs

The Gross Profit Margin

The term gross profit margin refers to the ratio between revenue and gross profit. If the business has a low margin, such as a grocery store, it means that COGS is high in relationship to revenues. The margin, or difference between revenues and COGS, is low. Businesses with a low margin need to make up for the low margin with a high volume of sales. Businesses with a high margin, such as a jewelry store or a high-end clothing store have low COGS compared to revenues.

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.  Further, as was earlier stated, 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. 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.

As you can see, 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.  In many ways, it can now be viewed and treated as a controllable cost.

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, the creation of metrics to measure COGS performance, and 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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