Mobius
Intermediate

What is COGS

Full name: Cost of Goods Sold

Also known as: cost of sales, direct costs, cost of goods sold

Formula

COGS build-up

COGS build-up+100Beginning Inventory+50Purchases+10Ending Inventory₪140Result

Illustrative example numbers. Tap a bar to see what it is. The formula itself is in the text below.

Definition

The direct costs of producing the goods or services sold by a business, including raw materials and direct labor. It covers direct production or acquisition costs during a specific period.

The direct cost attributable to the production or acquisition of the goods sold or services delivered by a company during a specific period.

Why it matters

Understanding COGS is essential for setting profitable prices and determining gross margin. If your direct costs are too high, scaling up will only accelerate your losses. Tracking COGS helps you optimize production efficiency and negotiate better rates with suppliers.

Directly related: Gross margin, Overhead, P&L.

Formula

COGS = Beginning Inventory + Purchases - Ending Inventory

Improvement tips

  • Negotiate bulk discounts with material suppliers to reduce unit costs.
  • Track direct labor hours carefully to ensure production time remains efficient.
  • Audit inventory regularly to identify and minimize material waste or shrinkage.

Common mistakes

  • Including indirect operating expenses like office rent or administrative salaries in COGS.
  • Failing to account for raw material price fluctuations when calculating product profitability.
  • Neglecting direct labor costs when calculating the COGS for service-based businesses.

Related terms

FinanceBeginner

Gross margin

The percentage of revenue a business retains after subtracting the direct costs of producing its goods or services. It shows the ratio of gross profit to net sales, per revenue dollar.

FinanceBeginner

Overhead

The ongoing administrative and operational costs required to run a business that are not directly tied to producing goods or services. Examples include rent, utilities, and administrative salaries.

FinanceBeginner

P&L

A financial statement that summarizes the revenues, costs, and expenses incurred during a specific period of time. Also called an income statement, it subtracts total expenses from revenues to measure performance.

StartupsIntermediate

Scaling

The process of growing a business by increasing output and revenue while keeping complexity and overhead costs from rising at the same rate.

From the blog

Negotiating With Suppliers: Terms That Protect Cash

How to negotiate supplier terms that improve cash flow, margin, delivery reliability, and operating stability without damaging the relationship.

Opening a Beauty Clinic in Israel: The Business Side Nobody Teaches

How to open a cosmetics clinic in Israel as a business, not just a profession: location, licensing, pricing treatments, filling the calendar, and surviving year one.

Quick check

What does COGS measure?

Choose an answer

Struggling with the numbers side of your business?

Alex helps Israeli owners get cash flow, pricing and profit under control. The first call is free.

Book a free callAsk on WhatsApp

Frequently asked questions

Do I need to understand COGS before I start my business?
Yes, understanding Cost of Goods Sold helps you determine the direct cost of producing your goods or services. This knowledge is essential for setting prices that cover production costs and ensure profitability.
When does COGS first become relevant for a new business?
Cost of Goods Sold becomes relevant when you calculate the cost of raw materials or direct labor needed to make your product. Calculating this early ensures your pricing covers the actual costs of delivery.
How do I calculate COGS for a startup that has not launched?
You can estimate Cost of Goods Sold by listing the prices of raw materials, manufacturing, and direct labor required to make one unit. Summing these costs gives you a baseline for your pricing strategy.
Is COGS relevant for a service-based business with no inventory?
Yes, service-based businesses have Cost of Goods Sold, which includes the cost of direct labor and tools used to deliver the service. For example, a consulting firm's Cost of Goods Sold includes the wages paid to the consultants for client projects.
Why does COGS matter for a business already running?
Cost of Goods Sold tells you exactly how much it costs to produce each item or service you sell. Monitoring this number helps you identify if supplier price hikes are eroding your profit margins.
What goes wrong when a business ignores its COGS?
Ignoring Cost of Goods Sold can lead to selling products at a loss, especially if material or manufacturing costs rise. This mistake can drain your cash reserves even if your sales volume is high.
How do I track COGS without stopping day-to-day operations?
You can track Cost of Goods Sold by linking your inventory management or bookkeeping system to your sales records. This setup automatically calculates direct production costs whenever a sale is made.
How can a business owner lower their COGS to improve profit?
You can lower Cost of Goods Sold by negotiating bulk discounts with suppliers, finding cheaper raw materials, or improving production efficiency. Reducing product packaging costs or shipping fees can also help.
What does COGS actually mean in plain words?
COGS stands for Cost of Goods Sold, and it represents the direct expenses you incur to make or buy the products you sell. It includes things like raw materials and direct factory labor.
Is COGS risky or complicated to calculate?
No, calculating Cost of Goods Sold is not risky or complicated. You only need to add up the costs that go directly into producing the items you sold during a period.
Do I need an accountant to calculate my COGS?
No, you do not need an accountant to calculate basic Cost of Goods Sold. You can find it yourself by tracking your material purchases and direct labor costs in a spreadsheet.
What is the difference between COGS and operating expenses?
Cost of Goods Sold only includes the direct costs of making a product, like fabric for a shirt. Operating expenses are the indirect costs of running the business, like rent, marketing, and office utilities.

Sources: Investopedia

Last reviewed: 2026-07-16