How to Uncover Cost of Goods Sold (COGS) Insights with Pharma Competitive Intelligence
COGS, aka the cost of goods sold, is one of the key intelligence questions that frequently emerge in the pharma competitive intelligence engagements. In this article, we describe the issues with COGS so that end-users leverage such intelligence judiciously in their pharma intelligence collection exercises. A direct implication is – the COGS affects the profitability and value-added as COGS feeds into the free cash flow generated by the pharma asset whose COGS one is seeking and thus impacts the value.
Understanding the meaning of COGS
One needs to understand what users mean by COGS. Do they mean the cost to manufacture or produce product X? Or are they referring to the COGS that they see in the financial statements of the company? Regarding the former, the absolute cost to manufacture a product is a confidential piece of information, and it is maintained in the management accounts of the company. The COGS which users see in the financial statements are for reporting purposes. COGS that is in the financial statements is calculated using the formula: cost of goods sold = starting inventory + purchases – ending inventory.
Methods of accounting items affect COGS
Companies use a variety of methods to account for their inventory. The usage of methods affects COGS. One might see the use of LIFO, FIFO, WACO methods etc. – if not, then a user might want to read the notes to the financial statements and know the accounting practices. Similarly, ‘purchase’ in the COGS formula is also affected by other variables, and this, in turn, impacts COGS.
Accounting policies affect COGS
The accounting for items that go into COGS is different in the US GAAP and European IFRS practices, so it is not possible to compare GAAP company accounts with IFRS accounts unless the reporting is adjusted to account for differences. However, one could compare a company’s COGS over time (longitudinal analysis) if accounting policies have not changed or altered due to significant M&A or other material activities that affect financial statements- remember the inventory is a Balance Sheet item while COGS is a P&L item.
Global footprint makes COGS intelligence complex
Pharma companies make products in different parts of the world. Even if one gets COGS intelligence by some means, it will be hard to benchmark or use that intelligence because such information is computed and documented using local management accounting practices. The pharma manufacturing and supply chain are normally split across many sites and countries (e.g. production, packing, labelling, fill and finish etc., generally are performed at different sites/countries), thus, the COGS is much more complicated. The true COGS is a weighted average of management accounts COGS at various sites provided the COGS are consistently defined and uniformly calculated or appropriately adjusted. Furthermore, the COGS is also compounded with currency exchange rates as different sites in the manufacturing chain use local currency for management accounts.
What does it mean for pharma COGS competitive intelligence seekers?
If a CI firm is providing COGS intelligence or claims to provide such intelligence via primary research, then the chances are that they are providing the financial reporting COGS – most CI firms equate the financial reporting COGS to the real cost of goods sold. Consequently, we recommend that the intelligence users:
- Check with the vendors about their understanding of COGS before delegating key intelligence questions
- Assess the quality of CI service that vendors propose to provide in this regard.
Internally, the end-users might want to be aware of the meaning of COGS on financial statements versus the real COGS intelligence that they might be seeking, and they should be mindful of the utility and caveats in using COGS intelligence.
BiopharmaVantage specializes in providing premium quality competitive intelligence services to pharmaceutical and biotechnology companies. If you would like to discuss how we can assist you, then please contact us.