Cost of goods sold (COGS)
Cost of goods sold is the direct cost of the products or services a business sold during a period: for a store, what the sold items cost; for a contractor, the labor, materials and subcontractor costs of the work delivered.
COGS sits between revenue and gross profit on the profit and loss. Revenue minus COGS is gross profit, and gross profit divided by revenue is gross margin. If costs are misclassified between COGS and overhead, both numbers mislead you.
Example
A store sells $50,000 in a month. The items sold cost $21,000 landed, so COGS is $21,000, gross profit is $29,000 and gross margin is 58 percent. If $4,000 of shipping supplies was coded to COGS by mistake, margin reads 50 percent instead.
Common mistake
Mixing overhead into COGS, or COGS into overhead. Owner salary, rent and office costs are not COGS; direct job materials are not overhead. The split decides whether gross margin means anything.
How to use it
Decide with your CPA which costs are direct for your business, keep the rule consistent, and watch gross margin monthly by product line, service or job. A falling margin with steady prices usually means costs are creeping or coded wrong.
COGS for product sellers
For an ecommerce or retail business, COGS starts with inventory. Purchases add to inventory at landed cost, and each sale moves the item's cost from inventory to COGS. That is why inventory accounting and COGS are the same conversation: get the inventory value wrong and COGS is wrong by the same amount. Freight in and duties belong in the cost; fulfillment and storage fees generally do not.
COGS for contractors and services
For a contractor, COGS is the direct cost of the work: job labor with its burden, materials, subcontractors and equipment used on the job. These are the same numbers job costing tracks by cost code, so a contractor with clean job costing already has clean COGS. Office staff, vehicles used generally and shop overhead are not COGS, even though they are real costs.
Why gross margin is the number to watch
Gross margin shows whether the core transaction makes money before overhead. Two businesses with identical revenue can have completely different lives at 30 percent and 55 percent margin. Watch the trend monthly and by segment. A margin that slides for three months is a pricing problem, a cost problem or a coding problem, and each has a different fix.
Common classification fights
The recurring questions: Are production wages COGS? Usually yes, with payroll taxes and benefits. Is the owner's time COGS? Only if your CPA sets it up that way. Are payment processing fees COGS? They can reasonably sit in COGS or in operating expenses; pick one and stay consistent. The rule matters less than applying it the same way every month.