What Is COGS?
Cost of Goods Sold represents the direct expenses tied to producing products or services a company sells. This crucial financial metric appears on income statements and directly impacts profitability calculations.
Key Components:
- Raw materials and inventory costs
- Direct labor expenses
- Factory overhead expenses
- Shipping and handling for production
How to Calculate Product Costs
Basic Calculation Formula:
Beginning Inventory + Purchases – Ending Inventory = Total Product Costs
Example Scenario:
| Component | Amount |
|---|---|
| Starting Inventory (Jan 1) | $50,000 |
| Quarterly Purchases | $120,000 |
| Ending Inventory (Mar 31) | $35,000 |
| Total Product Costs | $135,000 |
Why Tracking Product Costs Matters?
Business Benefits:
- Determines gross profit margins
- Helps price products competitively
- Identifies cost-saving opportunities
- Provides accurate tax reporting
Industry Applications:
- Manufacturing: Material + labor costs
- Retail: Wholesale purchase prices
- Services: Direct labor expenses
Different Accounting Methods
Inventory Valuation Approaches:
FIFO (First In, First Out)
Matches older costs with current revenue
Common during inflation periods
- LIFO (Last In, First Out)
Matches recent costs with revenue
Used for tax advantages
- Average Cost
Spreads costs evenly
Simplifies accounting
Common Mistakes to Avoid
Frequent Errors:
Including indirect costs like marketing
Miscounting inventory levels
Using inconsistent accounting methods
Forgetting to account for damaged goods
FAQs
Indirect expenses like:
Administrative salaries
Marketing campaigns
Office rent
Recommended frequency:
Monthly for growing businesses
Quarterly for established companies
Annually for tax purposes
Yes, including:
Consultant direct labor
Software tools for client work
Travel expenses for projects
- Product Costs: Directly tied to production
- OPEX: General business operations
