Cost of goods sold (COGS) is the total of the costs directly attributable to producing things that can be sold. COGS includes direct costs, such as material and labor, but does not include indirect costs, such as sales, marketing or distribution.
In accounting, COGS is a standard item in the expense section of a company's profit and loss statement (P&L). Costs can only be expensed and shown in the P&L after the goods have been sold and their revenues reported in the P&L. The cost of creating goods or services that are not sold should not be included.
COGS = Beginning Inventory + Purchases during the Period – Ending Inventory
Once the cost of goods sold has been found, the answer can be used to calculate a business’s gross income. This is the amount a business earns from sales before deducting taxes and other expenses.
Gross Income = Revenue – COGS
The gross profit can then be used to calculate the net income, which is the amount a business earns after subtracting all expenses.
Net Income = Revenue – COGS – Expenses
COGS is sometimes referred to as cost of merchandise sold or cost of sales. Some companies that sell a mix of products and services prefer a broader term, cost of revenue, of which COGS is one component.