Cost of goods sold (COGS) is the direct expenses related to producing and selling a product or service. It encompasses the cost of raw materials, direct labor, and manufacturing overhead expenses. COGS only includes the costs that are directly involved in the production of the goods or services that a business sells, and it is used to calculate a business's gross margin, which is the difference between revenue and COGS.
COGS is an important metric for businesses, particularly those that produce and sell physical goods, as it helps them to understand the efficiency of their operations and make informed decisions about pricing, production levels, and product mix. It also helps in identifying the profitability of a product or service.
There are various methods for calculating COGS, depending on the nature of the business and the information available. For example, businesses that purchase finished goods for resale will include the cost of the goods in COGS. In contrast, businesses that manufacture their own products will include all costs associated with production, such as raw materials, direct labor, and overhead.
It's important to note that COGS does not include indirect expenses, such as selling, general and administrative expenses, which are instead included in the operating expenses.