Cost of Goods Sold
Last reviewed 2026-05-11 by Asad Ali, Founder & CEO
The direct costs of producing goods sold by a company, including materials and direct labor.
Cost of goods sold (COGS) captures the direct expenses attributable to producing the products a company sells: raw materials, direct labor used in production, freight-in, and manufacturing supplies that become part of the finished good. COGS excludes indirect expenses like marketing, executive salaries, rent on the corporate office, and other overhead — those flow through operating expenses. COGS is subtracted from revenue on the income statement to produce gross profit, and the gross profit margin (gross profit ÷ revenue) is one of the most-watched indicators of pricing power and operational efficiency. For service businesses, the equivalent line is often called "cost of services" or "cost of revenue" and includes the labor and direct costs of delivering the service. Inventory costing method (FIFO, LIFO, or weighted average) materially affects COGS during periods of changing prices — LIFO produces higher COGS and lower taxable income when prices rise, but it's prohibited under IFRS and tracked closely by the IRS.
Formula
COGS = Beginning Inventory + Purchases − Ending Inventory. Equivalent under a perpetual inventory system: COGS = Sum of (Units Sold × Unit Cost) using FIFO, LIFO, or weighted-average costing.Example
A candle maker starts the month with $4,000 in inventory, purchases $9,000 in wax/wicks/jars, and ends the month with $3,000 in inventory. COGS = $4,000 + $9,000 − $3,000 = $10,000. The candle maker sold $20,000 in candles, so gross profit = $20,000 − $10,000 = $10,000, and gross margin = 50%. If raw-material costs jump 15% next month and the candle maker can't raise prices, COGS rises to roughly $11,350 and gross margin compresses to about 43% — a meaningful hit that quickly erodes net income.
Why It Matters for Your Business
COGS directly determines your gross profit margin. If you don't track it accurately by product line, you won't know whether your pricing covers production costs or which SKUs are quietly losing money.
Practical Tips
- •Track COGS by product line or SKU — average margin hides the fact that some products may be losing money on every sale
- •Choose your inventory costing method (FIFO, LIFO, weighted average) deliberately and document it — switching requires IRS Form 3115 and creates a taxable adjustment
- •Negotiate annual volume commitments with key suppliers in exchange for tiered discounts — this is usually more valuable than chasing one-time bulk deals
- •Reconcile your physical inventory count to your books at least quarterly — shrinkage hidden in COGS is a common warning sign of theft or process breakdown
Common Questions About Cost of Goods Sold
How is cost of goods sold calculated?
The formula is: COGS = Beginning Inventory + Purchases − Ending Inventory. Equivalent under a perpetual inventory system: COGS = Sum of (Units Sold × Unit Cost) using FIFO, LIFO, or weighted-average costing.. See the worked example below for a step-by-step calculation using realistic numbers.
What is an example of cost of goods sold?
A candle maker starts the month with $4,000 in inventory, purchases $9,000 in wax/wicks/jars, and ends the month with $3,000 in inventory. COGS = $4,000 + $9,000 − $3,000 = $10,000. The candle maker sold $20,000 in candles, so gross profit = $20,000 − $10,000 = $10,000, and gross margin = 50%. If raw-material costs jump 15% next month and the candle maker can't raise prices, COGS rises to roughly $11,350 and gross margin compresses to about 43% — a meaningful hit that quickly erodes net income.
Why does cost of goods sold matter for my business?
COGS directly determines your gross profit margin. If you don't track it accurately by product line, you won't know whether your pricing covers production costs or which SKUs are quietly losing money.
How does FiscalInsights help with cost of goods sold?
FiscalInsights tracks cost of goods sold automatically as part of its AI bookkeeping workflow. Connect your bank accounts and the platform handles categorization, reconciliation, and reporting without manual entry.
Related Terms
More Accounting Terms
Accounts Payable
Money owed by a business to its suppliers or creditors for goods or services received but not yet paid for.
Accounts Receivable
Money owed to a business by its customers for goods or services delivered but not yet paid for.
Accrual Accounting
An accounting method that records revenues and expenses when they are incurred, regardless of when cash is exchanged.
Asset
Any resource owned by a business that has economic value and can provide future benefits.
Balance Sheet
A financial statement showing assets, liabilities, and equity at a specific point in time.
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