COGS (also cost of goods sold) is the money a business spends to create, handle and deliver products to its customers. It may also be called cost of sales (COS).
Knowing the true cost of a sale is useful information for setting prices and calculating profits. For most small businesses, COGS are the same as direct costs. Service-based businesses tend to use the phrase cost of sales (COS).
Examples of COGS
- Buying inventory or raw materials
- Wages for employees who manufacture goods or deliver services
- Lease and energy costs for dedicated workshops or factories
Businesses may have different views about whether or not to count workshop or factory costs as COGS. They may also disagree about whether or not to count freight and warehousing. The most important thing is to settle on a definition that works for your business, and then apply it consistently.
Why COGS matter
A business needs to understand the true cost of serving its customers in order to settle on a competitive and profitable markup.
While materials and labor costs are typically easy to figure out, other COGS can catch out beginners. Small business owners that start out using their home as a production facility and warehouse may enjoy good margins, but that will change when they upgrade to dedicated manufacturing or warehousing premises. Their COGS will jump significantly to pay for those locations and the freight between them.
Monitoring COGS helps business owners identify and address the things that put pressure on their profit margins.
Deciding what is and isn’t COGS
Some businesses may focus solely on production or inventory costs when calculating COGS. Meanwhile some ecommerce businesses might take more of a lifetime view, including expenses like customer acquisition costs, online transactions fees, and shipping charges involved in the sale. Ecommerce (and online accounting tools) make it easier to attach all these ancillary costs to a particular sale.
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Disclaimer: This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.