COGS refers to the Cost of Goods Sold and the expenses that come with the production of goods. Understanding your COGS expenses can help you track your profitability and gross margins, providing insight into the success—or pitfalls—of your business.
However, it isn’t always clear what is included in the COGS. This guide will better help you sort out your COGS expenses and adjust as needed to increase your profitability.
What Are COGS Expenses?
The best way to track your COGS is to consider the expenses that come with assembling your products. This might seem easy at first, but the list of costs can add up.
A few common examples of COGS expenses include:
- The cost of items intended for resale
- The cost of raw materials
- The cost of parts needed to make a product or supplies needed
- Direct labor costs
- Overhead costs related to production
- Shipping and packaging costs
- Distribution and sales costs
For example, a company that sells candles would include the wax and wicks in the COGS, as well as the jars that hold the candles and the labels that promote them. The company would include the labor hours spent making the candles and the cost to use the factor to make them. When the candles are distributed to stores, the cost falls under the COGS.
What Is Excluded From COGS?
COGS does not cover indirect costs related to running a business. If your company contracts out a marketing agency to promote your brand, the monthly retainer does not count as part of your COGS. Salaried employees who aren’t directly related to production aren’t included in COGS (like human resource teams and executives).
Knowing what is excluded from the COGS is almost as important as knowing what to add. It can help you accurately calculate your gross margins and ensure the items you sell are profitable.
What Do You Do With Your COGS Expenses?
COGS is also known as the cost of doing business, or the idea that you must spend a certain amount to have the product you need to turn a profit. For example, you may need to spend $20,000 each year in COGS in order to sell $50,000 in profit.
COGS is also used for inventory management. If you are stuck with excess inventory, you can track the expenses related to creating it. This information is useful if you have nonperishable items that rollover from 1 financial year to the next or items with varying shelf-lives.
For example, a distillery would have a different COGS for different bottles of whiskey produced depending on how each label is made and how certain bottles are aged.
Develop Better Insight Into Your Finances
Tracking your COGS can help you produce better balance sheets and income statements for your business. This is just 1 step toward clearer financial insights and a path to growth.
To learn more valuable accounting terms, check out our Bookkeeping 101 guides that break down everything you need to know.