COGS
QUICK ANSWER
Cost of Goods Sold refers to the direct costs involved in producing the goods or services that a company sells during a specific period. It includes expenses such as raw materials, direct labor, and manufacturing overhead that are directly tied to production. COGS is subtracted from revenue to calculate gross profit.
In depth
COGS is recorded on the income statement and is one of the most closely watched line items in a business's financials. For product-based businesses, it includes the cost of materials and the labor required to make each unit. For service-based businesses, it typically includes the direct labor costs of delivering the service. It does not include indirect costs like marketing, administrative expenses, or rent, which are accounted for separately as operating expenses.
Tracking COGS accurately is essential for understanding true profitability. A rising COGS relative to revenue compresses gross margins and signals that production is becoming less efficient, raw material costs are increasing, or pricing needs to be adjusted. Businesses use inventory valuation methods such as FIFO, LIFO, or the average cost method to determine the specific cost assigned to goods sold in any given period, each of which can produce meaningfully different COGS figures and tax outcomes depending on the market environment.