What is cost of goods sold?
Cost of goods sold sits as the first expense line under revenue on an income statement, and revenue minus COGS equals gross profit. That single line isolates the direct cost of what sold, which lets owners set prices and see whether each product earns its keep.
COGS is also a tax concept. The IRS lets a business qualify as a small business taxpayer if it has “average annual gross receipts of $31 million or less for the 3 prior tax years,” which affects how it accounts for inventory.
The math behind the number is short, but clean records make or break it. Our guide to how to calculate COGS walks through each step.
Key characteristics
- Direct costs only: COGS includes materials, direct labor, and the freight or duties tied to buying goods. It excludes rent, marketing, and sales salaries.
- Formula-driven: Beginning inventory plus purchases minus ending inventory equals COGS. Accuracy matters because 78% of retailers deal with inventory inaccuracies on a weekly or monthly basis.
- Costing method changes the number: FIFO, LIFO, and weighted average assign different costs to the same units, so the method a business chooses shapes its COGS.
- Tied to inventory value: Under GAAP, FIFO and average-cost businesses value inventory at the lower of cost and net realizable value, and that carrying value feeds next period’s COGS.
- Matched to the period: COGS records the cost of goods in the period they sold, not the period they were bought.
Example
Picture a craft desk maker who builds solid-wood standing desks. She starts the quarter with $12,000 of finished desks and lumber, buys $8,000 more in wood, hardware, and finish, and ends with $5,000 of stock on the shelf.
Her COGS for the quarter is $12,000 + $8,000 − $5,000 = $15,000. If she sold those desks for $40,000, her gross profit is $25,000, before rent, ads, and other operating costs.
Related terms
- inventory valuation methods: how businesses assign cost to the units they sell.
- first in, first out (FIFO): assumes the oldest inventory sells first.
- last in, first out (LIFO): assumes the newest inventory sells first.
- landed cost: the full cost of purchased goods, including freight and duties.
FAQ
Is cost of goods sold an expense?
Yes. COGS is the first expense line beneath revenue on the income statement, and subtracting it from revenue produces gross profit.
What is not included in COGS?
Indirect costs stay out of COGS, including rent, marketing, sales salaries, and distribution. Those belong to operating expenses further down the income statement.
Do service businesses have COGS?
Businesses that sell only services usually report no COGS. Instead, they track a cost of services or cost of revenue line for the direct labor behind each job.
Accurate counts and valuation are what make COGS trustworthy, and Fishbowl keeps that discipline in one system that can sync inventory with QuickBooks for a cleaner close.