Cost of Goods Sold (COGS)

COGS is commonly expressed as inventory plus purchases minus ending inventory. Depreciation and other indirect costs such as clerical expenses or legal expenses are usually not considered with COGS and are listed separately. COGS appear on the income statement and may be deducted from revenue in order to ascertain the gross margin. If your company makes picture frames, for instance, your raw materials may include wood, glue, and glass, and those frames are made by five salaried workers. You spend $25,000 per month on those materials and an additional $12,500 on gross salaries for your employees. Your COGS would take into account those direct expenses. However it would not take into account indirect expenses such as the cost of shipping those frames to stores or the custom display shelves those stores use to sell your frames.

Using the above example, if you start August with $50,000 in inventory at your factory and spend $25,000 on new materials, then end August with $40,000 in inventory, your cost of goods sold for that month would be $35,000 (50,000+25,000-40,000).

You can also use COGS to determine the product gross margin percentage, or a portion of total sales revenue retained by a company after accounting for that company’s direct costs, by subtracting cost of goods sold from total sales revenue divided by total sales revenue. In the case of the frame shop, let’s say that your total product sales for August amounted to $86,000. Then, your product gross margin would be 59% (86,000 - 35,000 / 86,000). A high product gross margin percentage indicates that the frame company retains more on each dollar of sales for the purposes of funding its other, indirect costs, for instance, or paying down its debt.