What is Cost of Goods Sold?

Cost of goods sold, or COGS, is the cost of the inventory you sold, plus direct costs of producing or acquiring it. It is subtracted from revenue to calculate gross profit.

What it includes

For resellers: purchase price of goods sold, freight-in, duties and other costs to get goods ready for sale. For manufacturers: materials, direct labor and allocated production overhead. For some service businesses, direct costs such as subcontractors are shown in a similar "cost of sales" section.

The basic formula

Beginning inventory + purchases − ending inventory = cost of goods sold

This is how COGS is figured on Schedule C and business returns, as the IRS explains in Publication 334. A reliable ending inventory figure is essential.

Why it matters

COGS determines gross margin, which shows whether pricing covers direct costs. Errors are common:

• Expensing all inventory purchases immediately, which inflates COGS in buying months
• Leaving freight-in in a shipping expense account
• Ignoring shrink and damaged stock

COGS vs operating expenses

Rent, marketing, office salaries and software are generally operating expenses, not COGS. Keeping them separate makes gross margin meaningful.

See inventory accounting basics, FIFO and LIFO and landed cost.

Related terms

• Gross Profit: Gross profit is revenue minus cost of goods sold, before operating expenses.
• Operating Expenses: Operating expenses are the costs of running a business that are not directly tied to producing the goods or services sold.
• FIFO and LIFO: FIFO and LIFO are inventory costing methods that decide which purchase costs are assigned to the goods you sold.
• Landed Cost: Landed cost is the total cost of getting a product to your location ready for sale, including purchase price, freight, duties and fees.

Browse more definitions in the small business glossary.