Cost of Goods Sold (COGS) represents the direct costs incurred in producing or purchasing the goods that a company sells during a specific period. It includes expenses such as raw materials, direct labor, and manufacturing overhead directly tied to the production process. For businesses that resell products, COGS consists of the purchase price of the items sold, including shipping and handling costs.

COGS is a crucial component of the income statement and is subtracted from total revenue to determine gross profit. The formula for calculating COGS is:

COGS = Beginning Inventory + Purchases – Ending Inventory

This calculation helps businesses understand how efficiently they are producing or sourcing their products. Accurate COGS reporting is vital for assessing profitability, setting appropriate pricing, and managing inventory effectively.

It’s important to note that COGS does not include indirect expenses such as marketing, administrative salaries, or distribution costs. These are considered operating expenses.

Different inventory valuation methods—such as FIFO (First-In, First-Out), LIFO (Last-In, First-Out), and weighted average—can affect the COGS value, especially in times of inflation or price fluctuation.

In summary, COGS is a key metric that influences gross profit, tax obligations, and strategic financial planning.