Cost of Goods Sold, or COGS, represents the direct costs of producing or purchasing the products that a business sells. It includes expenses like raw materials, labor, and manufacturing overhead directly tied to the production of those goods. For example, a bakery’s COGS would cover ingredients like flour and sugar, as well as wages for bakers. It also excludes general business expenses like rent, marketing, and administrative costs, which aren't directly involved in creating the product​.
Calculating COGS gives a clear picture of gross profit and shows how much the business earns from its products alone:
Gross profit = Revenue – COGS
COGS = Beginning inventory + Purchased inventory – Ending inventory
COGS measures how much a business is spending directly on the products it sells. By knowing COGS, a business can understand if its pricing covers production costs and generates a decent profit margin. If COGS rises without an increase in sales prices, it directly eats into profit, meaning the business makes less money per sale​.
Furthermore, COGS helps identify areas for cost-saving. If labor or material costs are high, a business might consider cheaper suppliers or adjust production to be more efficient. It’s also an important number for tax reporting, as COGS can be deducted from revenue to reduce taxable income.Â
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