Cost of Goods Sold (COGS): Definition and How to Calculate It - NerdWallet (2024)

Calculating the cost of goods sold, often referred to as COGS in accounting, is essential to determining whether your business is making a profit. It involves a simple formula and can be calculated monthly to keep track of progress or even less frequently for more established businesses.

Costs of goods sold can include costs for:

Whether your business manufactures goods or orders them for resale will influence what types of costs you are likely to include. And not all service-based businesses keep track of cost of goods sold — it depends on how they use inventory.

For example, a massage therapist who keeps massage oil, towels and candles on hand to use when providing massages would not need to calculate the cost of goods sold because they are not selling the items to customers. Instead, they would include the cost of those items as tax deductions for operational costs.

However, a physical therapist who keeps an inventory of at-home equipment to resell to patients would likely want to keep track of the cost of goods sold. While they might use those items in the office during appointments, reselling that same equipment for patients to use at home plays a different role in cost calculations.

Cost of goods sold does not include costs unrelated to making or purchasing products for sale or resale or providing services. General business expenses, such as marketing, are often incurred regardless of if you sell certain products and are commonly classified as overhead costs.

Examples of costs that are not included in the cost of goods sold include:

To calculate the cost of goods sold, use the following formula for your chosen time period:

Beginning inventory + Inventory costs - Ending inventory = Cost of goods sold

Here’s an explanation of each variable:

Your business’s inventory cost accounting method determines how your inventory is valued, which ultimately affects your cost of goods sold, too. Here are the four most common inventory costing methods:

If you haven’t decided on a method yet, factor in how each may affect your cost of goods sold. For more information on how to pick an inventory valuation method, read our FIFO vs. LIFO explainer.

Let’s look at an example. Alexis started the month with stock that had a cost of $8,300, which is her beginning inventory. Over the month, she ordered materials to make new items and ordered some products to resale, spending $4,000, which are her inventory costs. At the end of the month, she calculated that she still had $5,600 in stock, which is her ending inventory.

To calculate her cost of goods sold for the month, her formula would be:

8,300 + 4,000 - 5,600 = $6,700

To calculate your cost of goods sold, use our calculator below.

Calculating profit

Correctly calculating the cost of goods sold is an important step in accounting. Any money your business brings in over the cost of goods sold for a time period can be allotted to overhead costs, and whatever is leftover is your business’s profit. Without properly calculating the cost of goods sold, you will not be able to determine your profit margin, or if your business is making a profit in the first place.

Adjusting pricing

A business’s cost of goods sold can also shine a light on areas where it can cut back to make more profit. You might be surprised to find that you’re making less profit than you expected with certain products. By analyzing the cost of goods sold for certain products, you can change vendors to order cheaper materials or raise your prices to increase your profit.

Completing financial statements

A business needs to know its cost of goods sold to complete an income statement to show how it’s calculated its gross profit. Businesses can use this form to not only track their revenue but also apply for loans and financial support.