What is Cost of Goods Sold (COGS)?

by
Cost of Goods Sold cover is made by Finsurlog and using image from yaicon Freepik

Cost of goods sold (COGS) is all about the direct expenses tied to making the products a company sells. This includes the costs for materials and labor that go straight into producing those goods. It doesn’t cover indirect costs like shipping or sales team expenses.

You might also hear cost of goods sold called “cost of sales.”

Why Is Cost of Goods Sold Important?

COGS is a key figure on financial statements since it gets deducted from a company’s revenue to figure out its gross profit. Gross profit is a measure of how well a company is handling its labor and materials during production.

Since COGS represents a business expense, it shows up on income statements. Understanding the cost of goods sold is crucial for analysts, investors, and managers to gauge a company’s profitability. If COGS goes up, net income takes a hit. While this can be good for tax reasons, it means less profit for shareholders. That’s why companies aim to keep their COGS low to boost their net profits.

Calculate Cost of Goods Sold

COGS=Beginning Inventory+P−Ending Inventory
where
P=Purchases during the period

Inventory that gets sold shows up in the income statement as part of the COGS. The starting inventory for the year is basically what was left over from the previous year—those items that didn’t sell.

Any new products made or bought by a manufacturing or retail business get added to that starting inventory. By the end of the year, any unsold products are taken out from the total of the starting inventory plus any new purchases. What you’re left with is the cost of goods sold for that year.

On the balance sheet, there’s a section called current assets, which includes an item for inventory. This balance sheet only reflects a company’s financial status at the end of a specific accounting period, meaning the inventory value listed under current assets is the ending inventory.

Conclusion

COGS refers to the direct expenses involved in making a product, covering things like materials and labor. COGS plays a big role in a company’s profits since it’s deducted from revenue. To boost profits, businesses need to keep an eye on their COGS. If they can lower these costs by negotiating better with suppliers or streamlining their production, they can increase their profitability.