What is the Cost of Goods Sold?
Cost of goods sold is the direct cost of the finished goods sold by a company within a specific period.
Cost of goods sold (COGS) does not take into account indirect costs such as distribution costs, sales force costs, or salaries and wages for the corresponding period.
Cost of goods sold is calculated by using the flow of inventory. Normally, inventory appears on a company’s balance sheet as a current asset, but the cost of goods sold calculation appears on the income statement.
COGS is also sometimes referred to as “cost of sales.”
Exploring the Cost of Goods Sold Formula
Cost of goods sold is calculated by adding purchases for the period to the beginning inventory for that same period, then subtracting the inventory at the period’s end.
This is summarized in the cost of goods sold formula as shown below.
Remember, this formula is used to calculate the cost of goods sold for a discrete period.
Whether that period is a month, a quarter, or a year, the COGS calculation is only helpful if it is constrained to a specific reporting period.
What Is COGS Used For?
Managers and other decision-makers keep a watchful eye on cost of goods sold metrics. If the direct costs of the finished goods balloon out of control, it can have a directly negative impact on profits.
For investors, financial analysts, and others, the cost of goods sold formula is used to calculate a company’s gross margin.
Gross margin is the amount of money left after subtracting all direct costs. It is a general profit metric at the company-level scale. To calculate gross margin, simply subtract the COGS number from the total revenue for that same period.
Gross margin can be expressed as the dollar value result or as a percentage by dividing the result by the total revenue for the period.
Cost of goods sold only covers direct product costs, meaning that indirect costs such as office expenses, rent, utilities, and administrative costs are not accounted for.
Internal managers and decision-makers monitor all costs with a close eye, and failing to take overhead costs—indirect costs not represented in the cost of goods sold calculation—into consideration could be disastrous for the overall bottom line of a business.