About

Accurate financial reporting hinges on precision. The Cost of Goods Sold (COGS) metric defines the direct costs attributable to the production of goods sold by a company. This includes material costs and direct labor but excludes indirect expenses like distribution or sales force costs. For retailers and manufacturers, errors here distort Gross Profit and taxable income.

Accountants and business owners use this metric to evaluate inventory turnover and pricing strategies. A low COGS relative to revenue indicates high efficiency, while a high figure suggests procurement issues or waste. The calculation requires strict adherence to inventory accounting periods.

Formulas

The fundamental equation relies on the periodic inventory system. It tracks the flow of value from the start of a period to its end.

{

COGS = I_start + P − I_endWhere:I_start = Beginning Inventory ValueP = Purchases during periodI_end = Ending Inventory Value

If manufacturing costs are involved, direct labor and overhead are added to the purchases component.

Reference Data

Industry Sector	Avg. COGS % (of Revenue)	Inventory Turnover
Retail (Clothing)	45-55%	4.0 x
Grocery / Food	70-75%	12.0 x
Software (SaaS)	10-20%	N/A
Manufacturing	60-70%	6.5 x
Restaurants	30-35%	50.0 x
Construction	80-85%	8.0 x
Pharmaceuticals	20-30%	3.0 x
Automotive	80-85%	5.0 x

Frequently Asked Questions

Only direct labor costs are included. Salaries for administrative staff, sales teams, or management are Operating Expenses (OPEX), not COGS.

If Ending Inventory is artificially high, COGS decreases. This inflates Gross Profit and taxable income, potentially leading to higher tax liability and misleading financial statements.

LIFO (Last-In, First-Out) and FIFO (First-In, First-Out) determine the value of the inventory sold. In inflationary periods, LIFO results in higher COGS and lower taxes, while FIFO results in lower COGS and higher profit.

Pure service businesses often have negligible COGS, referred to as "Cost of Revenue". However, if they sell physical products or have direct billable hours associated with a project, this logic still applies.