Cost of Goods Sold Formula: How to Calculate COGS Step-by-Step

COGS excludes indirect expenses like marketing, general administrative costs, and sales commissions, which are operating expenses. Other inclusions are landed costs (shipping, customs, insurance), packaging materials, and inventory write-downs. For manufacturers, it includes raw materials, direct labor, and manufacturing overhead like factory utilities and depreciation. This formula works for periodic inventory systems, while perpetual inventory systems track COGS in real-time with each sale.

Finale's weighted-average costing engine automatically recalculates the cost of goods sold formula after every transaction affecting inventory value. For a broader understanding of how these technologies work together, explore our guide to accounting and inventory software options for businesses at every growth stage. For growing businesses, consider upgrading to specialized inventory and accounting software for small business that automates these calculations.

In this guide, we'll clearly explain how to calculate COGS, what costs to include (and exclude), common mistakes to avoid, and practical examples to help you stay profitable and operationally efficient.
A retailer like Shane can choose to use FIFO (first-in, first-out) or LIFO (last-in, last-out) inventory costing methods.
The COGS calculation process allows you to deduct all the costs of the products you sell, whether you manufacture them or buy and re-sell them.
Inventory accounting journal entries for cost of goods sold generally require debiting the COGS and crediting the inventory account.
COGS does not include indirect expenses that are not directly tied to the production of goods.

How do estimates and judgments affect the COGS calculation?

This is multiplied by the actual number of goods sold to find the cost of goods sold. However, due to rising material prices, the last unit costs $10 to produce. It helps management and investors monitor the performance of the business. As revenue increases, more resources are required to produce the goods or service. Direct costs in producing a good or providing a service

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This figure should match the ending inventory from the previous period. Understanding this relationship helps managers make informed decisions about which products to promote or discontinue. Accurate COGS calculation is therefore crucial for pricing decisions, product mix strategy, and financial planning. This method is especially valuable for multichannel sellers tracking inventory across multiple locations with different acquisition costs. This method recalculates the average unit cost after each new purchase by dividing total inventory cost by total units.

Determining your beginning inventory's value shouldn't be too complicated. As stated above, your beginning inventory is the first critical figure to understand. As well, you will need to calculate your yearly COGS to accurately file your taxes at the end of the year. Once the data has been collected, we recommend running the formula once a month.

Every small business owner needs to know if their inventory-based business is profitable. In the final step, we subtract revenue from gross profit to arrive at – $20 million as our COGS figure. Here in our example, we assume a gross margin of 80.0%, which we’ll multiply by the revenue amount of $100 million to get $80 million as our gross profit. Calculating the COGS of a company is important because it measures the real cost of producing a product, as only the direct cost has been subtracted. The cost of goods sold (COGS) designation is distinct from operating expenses on the income statement. Under the matching principle of accrual accounting, each cost must be recognized in the same period as when the revenue was earned.

Another example could be company Z began the month with $6,700 worth of products, which she paid for upfront.
This is important to note because from this point forward, you'll only need to calculate your ending inventory.
Remember to regularly update your inventory records, as accurate data leads to accurate COGS calculations.
A good accounting software can help.
To use the inventory cost method, you will need to find the value of your inventory.
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Connecting COGS with broader cost accounting practices

The cost of goods sold (COGS) is a crucial financial metric that helps businesses determine their direct expenses for producing or purchasing goods sold during a given period. The formula to calculate the cost of goods sold calculates the direct costs of the goods a business sells during a specific period. In most cases, you should include purchases of products, supplies, and overhead expenses directly related to inventory. Cost of goods sold (COGS) represents the direct costs of manufacturing or purchasing the products a company sells, such as materials and labor. By subtracting the ending inventory from the sum of the beginning inventory and purchases, businesses can determine the cost of goods that were sold during the period.

This would mean you are only making $5.00 gross profit on each sale. You have 100 in stock and you calculate the cost of goods sold at $4500, or $45 per widget. Once your methods are chosen and your inventory values and purchases are totaled, it’s time to perform the COGS calculation.

Along with teaching at business and professional schools for over 35 years, she has author several business books and owned her own startup-focused company. Let our team of on-demand CPAs handle your accounting and technology, so you have more time to focus on what you are best at – running and growing your company. Slate can provide the support and insights you need to streamline your accounting processes, prepare complete and accurate financial reports, and make informed financial decisions. While cost of goods sold is easy to calculate, a few issues can trip you up.

And hoping nothing slipped through the cracks.In most businesses, the finance or accounting team handles COGS. Businesses typically calculate COGS for each accounting period, or may even make regular recalculations for accuracy. That's because it's one of the costs of doing business and generating revenue.

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So, for a factory producing sausage rolls, factory overheads would be included, whereas office rent for administrative staff would not. Additionally, service companies tend to use the cost of sales or the cost of revenue instead of COGS, as they don't sell actual goods. Companies that sell a service, rather than a good, often use the cost of sales or cost of revenue instead. The cost of goods sold is one of the biggest expense items for most companies. Mercury is a fintech company, not an FDIC-insured bank.

Cost of Goods Sold Calculation Examples

They are one of the top use the new charitable contribution break with your standard deduction financial metrics in accounting. Stay updated on the latest products and services anytime anywhere. Learn more about the best business accounting software available to you and uncomplicate your business accounting today. Keeping your business accounting in order is important.

COGS vs operating expenses (OPEX)

This means that the retailer spent $48,000 on goods that were actually sold during the period. However, COGS excludes indirect expenses such as marketing, administrative salaries, rent, or shipping to customers. Accurately calculating your cost of goods sold is fundamental—it shapes your pricing, profitability, and growth potential. Plus, you can integrate Rho directly with all of them—so your financial data flows cleanly, without the manual work.

You then sell 10, so your closing inventory is $90,000. On Jan 18 this year the balance of your opening inventory was 50 designer light shades, each worth $2,000. Through the COGS period, you purchase wool and cotton to make more items, along with additional items such as elastic and pre-made logos.

But you should know the information needed for this calculation, so you can collect all the information to include in this report. Inventory is an important business asset, with a specific value. Jean earned her MBA in small business/entrepreneurship from Cleveland State University and a Ph.D. in administration/management from Walden University. Jean Murray is an experienced business writer and teacher who has been writing for The Balance on U.S. business law and taxes since 2008.