One of the most important business accounting terms, COGS is the acronym for the cost of goods sold and represents the total cost required for a company to produce a product or deliver a service, including labor and materials. Calculating COGS is an important step in determining a business’ profitability. It is a central number on a P&L statement of inventory-based companies; without it, the gross profit margin cannot be determined.
For example, the cost of goods for retail businesses is the cost of inventory the business sells. It is typically accounted for on a sale-by-sale basis and uses what’s known as a perpetual inventory system in the point of sale software. For manufacturing firms, COGS includes all direct costs that go into a product’s production. In addition to labor and materials, some manufacturers include certain overhead costs when determining COGS, though this is not typically recommended.
Why are COGS important?
COGS is the first expense listed on the profit and loss statement and reducing this expense can help a company increase profits without having to increase sales. It is an important figure because it indicates the expenses involved every time a sale is made, a critical factor in setting prices. COGS also has tax implications; it is considered an expense which means the larger it is, the lower a company’s taxable income.