Cost of Goods Sold
COGSCost of Goods Sold (COGS) represents the direct costs of producing the goods sold by a business.
Cost of Goods Sold (COGS) includes all direct expenses incurred in manufacturing a product. These costs cover raw materials, direct labor, and manufacturing overhead. Direct materials are the physical components of the final product. Direct labor is the wages paid to workers who assemble or fabricate the product. Manufacturing overhead includes factory rent, utilities, and equipment depreciation. COGS does not include indirect costs like marketing, sales commissions, or administrative salaries.
On the shop floor, tracking COGS is essential for measuring profitability and operational efficiency. A high COGS relative to revenue can indicate wasted materials, inefficient labor, or excessive overhead. Managers analyze COGS to make informed decisions. They can adjust product pricing, find less expensive material suppliers, or invest in automation to reduce labor costs. This metric directly connects production activities to the company's financial health.
Manufacturers calculate COGS for a specific accounting period, like a month or a quarter. The calculation starts with the value of beginning inventory. It adds the cost of new purchases and subtracts the value of ending inventory. Accurate inventory tracking through an ERP or inventory management system is critical. Bill of Materials (BOMs) and production routings must be precise to assign costs correctly to each product.
A machine shop starts the month with $50,000 in raw steel inventory. During the month, it purchases an additional $30,000 of steel. At the end of the month, a physical count shows $20,000 of steel remains. The COGS for raw materials that month is $60,000 ($50,000 + $30,000 - $20,000).
What is the difference between COGS and operating expenses?
COGS are direct production costs like materials and factory labor. Operating expenses are indirect costs needed to run the business, such as sales salaries and office rent.
How does my inventory valuation method affect COGS?
Methods like FIFO or LIFO change the cost assigned to sold inventory. This directly impacts the COGS calculation and your reported gross profit.
Are shipping costs included in COGS?
The cost to ship raw materials to your factory (freight-in) is part of COGS. The cost to ship finished products to customers (freight-out) is a selling expense.
Why did my COGS increase if my production volume was flat?
Your COGS could increase due to higher raw material prices from suppliers. It could also rise because of increased labor wages or higher factory utility bills.
Does COGS include the cost of unsold inventory?
No, COGS only accounts for the cost of inventory that has been sold during the period. The cost of unsold inventory remains on the balance sheet as an asset.
Bill of Materials
BOMA Bill of Materials (BOM) is a complete list of the raw materials, components, and assemblies required to build a product.
Job Costing
Job costing is an accounting method that tracks the costs of materials, labor, and overhead for a specific manufacturing job or work order.
Landed Cost
Landed cost is the total expense of a product, including its purchase price, shipping, insurance, duties, and other fees, until it arrives at the buyer's facility.
Work in Progress
WIPWork in Progress (WIP) is the inventory of partially finished goods waiting for completion and final inspection.
Finished Goods
Finished goods are products that have completed all manufacturing processes and are ready to be sold to customers.