COGS (Cost of Goods Sold)

Cost of goods sold (COGS) represents the direct costs attributable to producing the products or delivering the services your business sells. It's the first expense subtracted from revenue on your profit and loss statement, and it's what separates your total revenue from your gross profit.

For a product-based business, COGS includes raw materials, component parts, direct labor (the people actually making the product), manufacturing supplies, and shipping costs to get materials to your facility. For a service business, COGS (sometimes called cost of services) includes the direct labor costs of delivering the service and any materials consumed in the process. What's NOT included in COGS: rent for your office, marketing costs, administrative salaries, insurance — those are operating expenses, not direct costs.

Calculating COGS for a period typically uses this formula: Beginning Inventory + Purchases During the Period - Ending Inventory = COGS. This inventory-based calculation captures the actual cost of the goods that were sold, not just what you bought. If you started the month with $10,000 in inventory, bought $5,000 more, and ended with $8,000, your COGS is $7,000 — that's the cost of the inventory that left your shelves.

COGS directly determines your gross margin, which is the single most important indicator of whether your pricing and production costs are sustainable. If COGS is too high relative to revenue, no amount of sales volume will make you profitable — you're losing money on every unit sold. Tracking COGS over time also reveals cost trends: are material costs rising? Is labor becoming more expensive? Are you getting less efficient? On the tax side, COGS is deductible — it reduces your taxable income. Accurately tracking COGS means you're not overpaying taxes by understating your costs.