How To Calculate Your Cost of Goods Sold (COGS)
If your business sells products, understanding how to calculate your cost of goods sold (COGS) is essential. It helps ensure you’re pricing your goods correctly, managing production costs, and calculating your gross and net profit accurately.
Plus, if you’re applying for business loans or grants, many lenders, including the SBA, still ask for your COGS. In this post, we’ll break down what COGS is, why it matters, and how to calculate it step by step.
Related:
What Is the Cost of Goods Sold (COGS)?
COGS refers to the direct costs involved in producing or acquiring the products your business sells. This typically includes:
- Raw materials
- Direct labor
- Utilities used in production
It does not include overhead expenses like marketing, admin, or distribution costs.
Example: If you make candles and sell them on Etsy, your wax, jars, and wicks count as COGS. The ads you run on Instagram do not.
If you’re a digital seller or small-scale creator, you may still be able to deduct COGS-related expenses (like shipping raw materials) on your taxes, even without a traditional factory setup.
Why Is COGS Important?
COGS is essential because it directly impacts your gross profit margin, a key metric in determining how efficiently your business is operating.
Gross Profit = Revenue - COGS
The lower your COGS, the higher your profit. It’s also a critical number for funding:
Lenders and grant programs may request it to calculate your loan eligibility or business health
Common Examples of COGS?
While definitions can vary slightly by industry, here are examples of expenses generally included in COGS:
- Raw materials (e.g., flour, fabric, metal, etc.)
- Products purchased for resale (e.g., wholesale goods)
- Labor directly tied to production
- Utility costs specific to manufacturing
- Packaging and storage for inventory
Note: Not every business will have the same COGS structure. When in doubt, consult a tax pro.
Which Businesses Do Not Have COGS?
The IRS states that if the sale of merchandise isn’t an income-producing activity for your business, you likely don’t have to calculate COGS. This applies to service-based professionals like:
- Consultants
- Real estate agents
- Therapists
- Lawyers
If your business doesn’t carry inventory, COGS may not apply, or may look very different.
Are Software and SaaS Companies Exception?
Yes, sort of. Even though they don’t carry physical inventory, SaaS businesses often still calculate COGS to understand margins and track financial performance.
Common COGS-like expenses for SaaS include:
- Web hosting & infrastructure
- Developer salaries tied to the product
- Customer support teams
- Third-party APIs or tools
Note: If you’re in SaaS or digital services, talk to your accountant about which costs are considered direct and deductible.
How Do You Calculate COGS?
Here’s the basic formula:
COGS = Beginning Inventory + Purchases During Period - Ending Inventory
Example:
Beginning inventory: $10,000
Purchases during the quarter: $6,000
Ending inventory: $4,000
COGS = $10,000 + $6,000 - $4,000 = $12,000
This tells you how much you spent to produce the goods you sold in a specific time period.
Do You Want Personalized Business Help?
Understanding your COGS is just one part of running a strong business. If you’re looking for:
- Help organizing your finances
- Personalized support applying for grants or loans
- Tools to track your progress
Skip can help. Book a 1-on-1 call with a Skip expert.
Disclaimer: This article is meant to be used for illustration purposes only. This is not intended to provide tax or accounting advice.