What is cost of goods sold (COGS)?

What COGS means

COGS, also called cost of sales, covers only the costs that go directly into what you sell. For a shop that means the stock it resold. For a manufacturer it includes raw materials, factory labour and production overheads. For a service business the equivalent is direct costs such as subcontractors working on client jobs.

Costs that would exist whether or not you sold anything, such as office rent, marketing and admin salaries, are overheads, not COGS.

For businesses holding stock, the formula is:

COGS = opening stock + purchases − closing stock

Example

An online homeware shop counts its stock at the start and end of the year:

Item	Amount
Opening stock at 1 April	£14,000
Stock purchased in the year, including inbound delivery	£96,000
Less closing stock at 31 March	(£18,000)
Cost of goods sold	£92,000

With sales of £210,000, gross profit is £118,000, a gross margin of 56%.

Why it matters for your business

COGS drives gross profit, which tells you whether your pricing works before overheads. If gross margin is slipping, look at supplier prices, discounting and waste before cutting overheads.

Closing stock has a direct effect on profit and tax: overstate it and COGS falls, profit rises and you pay more tax; understate it and the opposite happens. Count stock properly at the year end, value it at the lower of cost and net realisable value, and write down anything damaged or obsolete. Methods such as FIFO decide which costs flow into COGS when purchase prices change.

For ecommerce sellers, include the costs of getting goods to a saleable state (purchase price, import duty, inbound shipping). Marketplace fees and outbound postage are usually shown as selling costs below gross profit, but be consistent from year to year.

COGS vs operating expenses

COGS rises and falls with sales. Operating expenses mostly stay put. That split is what makes break-even and margin analysis possible.

How to work it out each month

Cloud accounting software can post cost of sales automatically if you track stock in it or in a linked inventory app. Without that, many small retailers estimate monthly COGS using their expected gross margin and correct it with a full stock count at the year end. A large correction at year end is a sign the monthly estimates, or stock records, need attention.