Cost of Goods Sold (COGS): Definition and Calculation

Cost of Goods Sold is a key metric for understanding your company’s true profitability. Yet it is often miscalculated or underutilized, which can distort margins and lead to poor business decisions.

Whether you operate in distribution, retail or manufacturing, understanding your COGS helps you control costs more effectively, adjust pricing strategies and improve overall financial performance.

What Is Cost of Goods Sold (COGS)?

Cost of Goods Sold (COGS) represents all direct costs incurred to produce or acquire the goods sold during a given period. It measures the actual cost of the products that generated revenue.

COGS is a fundamental financial metric used to evaluate a company’s gross profit and overall profitability.

What Costs Are Included in COGS?

COGS includes only costs that are directly related to producing or purchasing goods sold, including:

• Raw materials used in production;

• Direct labour (employees directly involved in manufacturing);

• Freight and procurement costs related to inventory;

• Packaging and product preparation costs;

• Manufacturing overhead costs (for manufacturing companies only), including factory-related expenses such as machine maintenance, equipment depreciation, energy consumption, warehousing and similar production-related costs.

These costs generally vary according to production or sales volume.

What Costs Are Excluded?

Certain expenses are necessary to operate a business but are not included in COGS, such as:

• Marketing and advertising expenses;

• Administrative expenses (accounting, management, etc.);

• Sales and administrative salaries (executives, HR personnel, sales representatives, etc.);

• Rent, infrastructure costs and fixed expenses related to sales and administration.

These costs are considered operating expenses and are reported separately from COGS.

How Do You Calculate Cost of Goods Sold?

Calculating Cost of Goods Sold allows businesses to determine the value of products actually sold during a given period. It is a critical metric for measuring gross margin and monitoring profitability.

The COGS Formula

The most common formula is:

Beginning Inventory + Purchases – Ending Inventory = COGS

In other words, you start with the value of inventory at the beginning of the period, add purchases and production costs incurred during the period, then subtract the value of inventory remaining at the end.

This calculation isolates the cost of goods that were actually sold.

Example

Consider the following example:

• Beginning Inventory: $10,000

• Purchases During the Year: $25,000

• Ending Inventory: $8,000

Calculation:

$10,000 + $25,000 − $8,000 = $27,000

The Cost of Goods Sold for the period is therefore $27,000.

What Is the Difference Between COGS, Cost Price and Operating Expenses?

These three concepts are frequently confused, but they serve very different purposes in financial analysis.

COGS helps analyze the immediate profitability of sales through gross margin, while cost price provides a complete picture of product profitability. Operating expenses influence the company’s overall net profit.

How Can You Reduce COGS and Improve Profitability?

Reducing COGS does not simply mean cutting costs. The objective is to optimize operations and improve margins without compromising quality or customer value.

Here are some recommendations from Mallette’s experts.

Negotiate with Suppliers

Raw material and inventory costs directly affect COGS.

Consider:

• Renegotiating prices and terms;

• Consolidating purchases to obtain volume discounts;

• Diversifying suppliers to reduce supply risks.

Even small purchasing improvements can significantly increase margins.

Optimize Production Processes

Inefficient processes generate unnecessary costs.

Strategies include:

• Improving production methods;

• Reducing downtime;

• Standardizing repetitive tasks.

A more efficient production environment lowers unit costs.

Reduce Waste and Material Losses

Material waste and production errors increase COGS directly.

Focus on:

• Better control of material usage;

• Reducing scrap and rework;

• Strengthening quality control procedures.

Less waste means greater profitability.

Automate Repetitive Processes

Automation can reduce labour costs and improve accuracy.

Examples include:

• Automating repetitive tasks;

• Implementing digital tools;

• Reducing human error.

Appropriate automation improves productivity and operational performance.

Improve Inventory Management

Poor inventory management can increase costs without being immediately visible.

Key actions include:

• Avoiding overstocking and excess capital tied up in inventory;

• Preventing stockouts that lead to costly emergency purchases;

• Monitoring inventory turnover.

Effective inventory management improves both COGS control and cash flow.

COGS by Business Type

Although the concept remains the same, COGS is calculated differently depending on your business model.

Retail Businesses

For retail businesses, COGS primarily consists of the purchase cost of goods resold.

Typical components include:

• Merchandise purchases;

• Procurement-related costs such as freight and customs duties;

• Inventory adjustments (beginning and ending inventory).

Manufacturing Companies

For manufacturers, COGS includes production costs such as:

• Raw materials;

• Direct labour;

• Production-related expenses (energy, specific subcontracting, etc.);

• Changes in raw materials, work-in-progress and finished goods inventories.

Service Businesses

For service companies, the concept is generally adapted as the Cost of Services Rendered.

Typical components include:

• Direct billable labour hours;

• Resources assigned to service delivery (consultants, technicians, etc.);

• Subcontracting costs;

• Tools and expenses directly related to delivering the service.

Improve Profitability by Understanding Your Costs

At Mallette, our specialists help organizations analyze cost structures, improve profitability and develop pricing strategies aligned with their market realities.

We help transform financial data into practical business decisions tailored to your organization.

Learn how to establish the right pricing for your products and services and maximize profitability through a structured and strategic approach.