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Cost of Goods Sold (COGS)
Calculates the direct costs attributable to the production of goods sold, including inventory, purchases, and direct labor.
How to Calculate Cost of Goods Sold (COGS)
The formula to calculate this metric is straightforward.
COGS = Beginning Inventory Value + Inventory Purchases + Direct Labor - Ending Inventory Value
A Real-World Example
Scenario: On January 1st, your warehouse holds $30,000 worth of stock assets. Throughout the year, you spend $85,000 importing component parts. On December 31st, your closing inventory audit measures remaining stock at $20,000.
COGS: $30,000 + $85,000 - $20,000 = $95,000
The true asset cost required to fuel your year sales volumes totals $95,000.
Why Cost of Goods Sold (COGS) Matters for Your Business
- Serves as the foundation for isolating your business true Gross Profit before deducting operational overhead.
- Required by tax authorities to correctly calculate business deductions and net tax obligations.
- Highlights raw manufacturing and sourcing efficiency, showing if supplier price changes are cutting into your profitability.
Frequently Asked Questions
What expenses should be included in a COGS calculation?
Include raw material costs, supplier wholesale invoices, direct manufacturing labor, freight-in shipping fees, and custom import duties.
Should I include office rent or software tools within my COGS?
No. Office rent, advertising spend, and standard software platforms are classified as operating expenses (OpEx) and are deducted after calculating gross profit.
Why is tracking COGS correctly so critical for product pricing?
Without a clear grasp on your true COGS, you risk pricing your products too low, which can cause you to lose money on every sale once shipping and materials are added up.