Cost of goods sold (COGS)

Definition of COGS: Cost of Goods Sold is the cost incurred by a company which is directly related to the revenue it earned. This term appears in a companies Income statement typically just below the total revenue or top-line number. For a manufacturing company, which makes physical goods, COGS indicates the cost raw materials, labor and other costs directly related to making of the physical goods. For a company, which earns its revenue from services, the COGS would contain all the costs that are directly related to rendering the service. For such a company it is more appropriate to use the term Cost of Sales.

Cost of Goods Sold Explained:

The only costs included in COGS are the costs directly related to making of the product that a company sales. It will include costs like material costs, direct labor and energy costs involved in making of the product. These are distinguished from the General and Administrative costs like rent for premises, salaries of employees not directly related to producing the goods etc. Other costs like transport, sales, advertising etc. are also not included in COGS.
In complex manufacturing unit, it might be difficult to exactly calculate the COGS for a product for a period as the product may have a lot of components purchased at different times. Normally companies arrive at the COGS for a period by subtracting the cost of inventory at end of the period from the period beginning inventory plus the inventory purchases during that period.
It is important to separate COGS and other costs that a company incurs to understand its profitability. If we subtract the COGS from the top line revenue, we get gross profit of the company. Gross profit divided by the total sales gives the important profitability number called as 'Gross Profit margin' that a company has.

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