What is Cost of goods sold (COGS)?

Cost of goods sold, or COGS, is what the items you sold actually cost you. For a retailer that means the purchase price of the merchandise plus the costs to get it onto the shelf, such as inbound freight, duties and brokerage. For a restaurant it is the cost of the food and drink that went out to tables. Rent, wages for front-of-house staff and marketing are operating expenses, not COGS.

The periodic formula is beginning inventory plus purchases minus ending inventory. It works, but only as well as your stock count. A perpetual inventory system calculates COGS line by line instead: each time an item sells, its cost (by average cost, FIFO or another method) moves from inventory on the balance sheet to COGS on the income statement. That gives a daily, item-level gross margin rather than a once-a-quarter estimate.

COGS sits directly under revenue on the income statement, and revenue minus COGS is gross profit. Because it is usually the largest cost for product businesses, small errors here distort profit badly. Common causes are missing freight from item costs, not recording waste or shrinkage, and counting inventory inconsistently. Tracking landed cost and doing regular cycle counts keeps the number honest.