What Is Cost of Goods Sold?

What COGS means

COGS includes only the costs that go up when you sell more and down when you sell less. For a shop, it's the wholesale cost of products. For a manufacturer, it's raw materials and production labour. For a service business, it's often direct labour and any materials used on the project.

Why it matters for small business

COGS sits between revenue and gross profit. Lowering COGS (without hurting quality) directly improves your profitability. Tracking it carefully is essential for pricing and supplier decisions.

Simple formula

For a service business with no physical inventory, COGS is usually just the direct cost of delivering each project.

Practical example

A small clothing shop starts the month with $5,000 in stock, buys $3,000 more during the month, and ends with $4,000 still on the shelves.

That $4,000 represents the cost of the goods actually sold in the month.

What is NOT in COGS

• Rent of the store or office
• Marketing or advertising
• Admin salaries
• Software subscriptions for general business use

Those belong in operating expenses.

Common mistakes

• Mixing personal and business purchases. Only inventory bought for resale belongs here.
• Not counting freight in. Shipping costs to get inventory to you usually count as part of COGS.