Cost of sales (definition)
Cost of sales (COS) represents all the costs that go into providing a service or product to a customer. It may also be called cost of goods sold (COGS).
Businesses need to know the cost of serving customers in order to set competitive and profitable prices. For most small businesses, cost of sales are the same as direct costs.
Examples of cost of sales
- Buying inventory or raw materials
- Wages spent on making products or delivering services
- Lease and energy costs associated directly with production or delivering the work
Businesses may have different views about whether or not to count lease and energy expenses in their cost of sales. 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 cost of sales matters
Understanding the cost of sales helps businesses calculate how profitable each transaction has been.
While labor costs are typically easy to figure out, other costs can catch out beginners. Freelance teams that start out using their home as an office will enjoy good margins initially, but that will change when they have to pay office rent.
Monitoring cost of sales helps business owners identify and address the things that put pressure on their profit margins.
Deciding what is and isn’t cost of sales
Some businesses may focus solely on production or service delivery when calculating cost of sales. Other businesses might take more of a lifetime view by including expenses such as sales commissions, referral fees, and online transaction fees for accepting card payments.
See related terms
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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.