Updated: December 24, 2024
The cost of goods sold (COGS) calculator at the top of this page can help you to understand the direct costs associated with selling your merchandise. For manufacturers, this is generally the largest expense on the income statement. So, effectively managing it is key to increasing profitability.
In addition, we spoke with Tom Brock, a licensed CPA, and CFA Charterholder, with over a decade of experience helping small businesses for his insights on why understanding your company’s costs of goods makes good business sense.
What is cost of goods sold (COGS)
“Cost of goods sold (COGS) is a financial metric that reflects the direct costs incurred by a company in producing the goods it sells. As implied, COGS is generally associated with manufacturing companies, but it also applies to service-based companies. However, these companies refer to the metric as cost of revenue or cost of sales rather than cost of goods sold.”
— Tom Brock, Certified Public Accounting (CPA) and Chartered Financial Analyst (CFA)
What does COGS include?
COGS includes all expenses directly associated with the production process. These costs are categorized as follows:
- Raw materials: This category reflects the cost of materials used to manufacture products.
- Direct labor: This category reflects wages paid to workers directly involved in the production process.
- Manufacturing overhead: This category reflects overhead expenses that directly support the manufacturing process. Examples include factory rent, factory utilities and equipment depreciation.
What is not included in COGS?
COGS includes all direct costs associated with producing a good. COGS excludes all indirect costs associated with running a business. These expenses, which are known as operating expenses, include, but are not limited to, executive salaries, non-production staff salaries, marketing expenses, and insurance expenses.
Why should businesses understand COGS?
Understanding COGS can help business leaders more effectively run their operations in a myriad of ways. Specifically, it can help you manage inventory, optimize pricing strategies and produce accurate financial reports.
Once more, we caught up with Tom Brock, who puts it this way when it comes to keeping up with COGS.
“Ultimately, understanding and systematically monitoring COGS can help you drive profitability.”
— Certified Public Accounting (CPA) and Chartered Financial Analyst (CFA)
COGS: How do you calculate cost of goods sold
COGS is computed by adding inventory purchases to beginning inventory and subtracting ending inventory. When determining the beginning and ending inventory values, remember that inventory consists of three components – raw materials, works-in-progress and finished goods.
What is the cost of goods sold formula?
The COGS formula is expressed as follows:
- COGS = Beginning inventory + inventory purchases – ending inventory
The resulting figure indicates the cost of inventory sold during the period. Incidentally, COGS should be calculated at the end of each accounting period, which generally occurs on a monthly or quarterly basis.
What is an example of a COGS?
To better understand COGS, let’s explore a hypothetical scenario. Details are below.
Company name: Wiseworks Inc.
Reporting period: July 1, 2024 – September 30, 2024
Beginning inventory:
- Raw Materials = $50,000
- Works-in-progress = $25,000
- Finished goods = $25,000
Inventory purchases: $75,000
Ending inventory:
- Raw Materials = $75,000
- Works-in-progress = $40,000
- Finished goods = $10,000
Calculating COGS entails the following four simple steps:
- Compute beginning inventory. This entails adding the values of the three components of inventory (raw materials, works-in-progress and finished goods) at the beginning of the accounting period. For Wiseworks, the value is $100,000.
- Determine inventory purchases. This entails identifying the amount of inventory purchased during the accounting period. For Wiseworks, the value is $75,000.
- Compute ending inventory. This entails adding the values of the three components of inventory (raw materials, works-in-progress and finished goods) at the end of the accounting period. For Wiseworks, the value is $125,000.
- Calculate COGS. This entails leveraging the COGS formula, which is illustrated below.
COGS = Beginning inventory + inventory purchases – ending inventory
- COGS = $100,000 + $75,000 – $125,000 = $50,000
More to know about COGS
Is COGS tax deductible?
COGS is a tax deductible business expense. COGS reduces taxable income, thereby reducing income tax.
Is cost of goods sold an asset?
COGS is an expense, not an asset. It represents the cost associated with transforming raw materials into a marketable product and, ultimately, accounts receivable or cash (via the sale of the marketable product).
What is the difference between COGS and operating expenses?
COGS and operating expenses are both expenditures incurred in the course of running a business, but they are reported distinctly, because they represent different things. COGS represents the direct costs associated with the production process, while operating expenses represent indirect costs associated with day-to-day operations (i.e., non-production salaries, marketing expenses, insurance expenses, etc.).
