Cost of Goods Sold (COGS)
→ Use the Cost of Goods Sold (COGS) CalculatorWhat is Cost of Goods Sold (COGS)?
Cost of Goods Sold (COGS) is the aggregate of all direct costs incurred to produce the goods or deliver the services a company sells during a period. For a product business, this typically includes raw materials, direct labour (workers on the production line), and manufacturing overhead (factory rent, utilities, equipment depreciation). For a service business, it includes direct labour hours billed to clients and any direct project costs.
COGS is the first deduction from Revenue on an income statement: Revenue − COGS = Gross Profit. The lower the COGS relative to revenue, the higher the gross margin — and the more resources available to fund operations, R&D, and profit.
What counts as COGS varies by industry and accounting policy. Software companies often count only hosting costs and customer support as COGS. Professional service firms count only billable hours. Retailers count the wholesale cost of goods sold. Understanding what a company includes in COGS is essential for cross-company margin comparisons.
When to use Cost of Goods Sold (COGS)
Use COGS to calculate Gross Profit and Gross Profit Margin — the first indicators of unit economics and pricing power. Analyse COGS trends over time to identify whether input costs (materials, labour) are rising relative to revenue, which squeezes margins. In due diligence, verify the composition of COGS to ensure no operating costs are being hidden below the gross profit line.
Worked examples
| Business type | Revenue | COGS components | COGS | Gross Profit |
|---|---|---|---|---|
| Manufacturer | $10,000,000 | Materials + Labour + Factory OH | $6,500,000 | $3,500,000 |
| Retailer | $5,000,000 | Wholesale cost of goods | $3,250,000 | $1,750,000 |
| SaaS company | $8,000,000 | Hosting + Support staff | $1,600,000 | $6,400,000 |
Common pitfalls
Companies can improve reported gross margins by reclassifying costs from COGS to operating expenses. A sudden improvement in gross margin without a corresponding operational change may indicate reclassification. Always compare gross margin trends against peers using consistent COGS definitions.
Frequently asked questions
What is the difference between COGS and operating expenses?
COGS covers only direct production costs — the costs that vary directly with units produced or services delivered. Operating expenses (SG&A, R&D) are the overhead costs of running the business. COGS appears above Gross Profit; OpEx appears below it.
Does COGS include salaries?
Only direct labour salaries — wages paid to workers directly involved in production or service delivery. Salaries of sales, marketing, HR, and executive staff are OpEx (SG&A), not COGS.
How is COGS calculated for a retailer vs a manufacturer?
For a retailer: COGS = Beginning Inventory + Purchases − Ending Inventory. For a manufacturer: COGS = Beginning Finished Goods + Cost of Goods Manufactured − Ending Finished Goods, where cost of goods manufactured includes materials, direct labour, and factory overhead.