Cost of goods sold (COGS) is the direct cost of producing or purchasing the goods a business sold during a period.
COGS includes raw materials, direct labor, and manufacturing overhead — but not selling expenses, administrative costs, or interest. It appears on the income statement as a deduction from revenue:
- Revenue minus COGS equals gross profit.
- Gross profit minus operating expenses equals operating income.
COGS matters because it separates the cost of what was sold from the cost of running the business. This makes it possible to assess whether the core product or service is profitable before overhead enters the picture.
What counts as COGS depends on the type of business. For a retailer, COGS is the purchase price of inventory sold. For a manufacturer, it includes materials, production labor, and factory overhead. Service businesses often don’t have COGS at all — their costs tend to fall under operating expenses instead.
The formula for calculating COGS in a periodic inventory system is: beginning inventory plus purchases minus ending inventory. In a perpetual system, the accounting software tracks COGS in real time as each sale occurs.
Related terms
- Income statement — the financial statement where COGS appears as a deduction from revenue.
- Account — the ledger record that tracks COGS balances.