COSTS OF GOODS SOLD: Definition, Meaning, and Why It Matters
- Apr 5
- 2 min read
COGS (Costs of Goods Sold) are the direct costs involved in producing or purchasing the "goods" that a business sells. Goods refer to both physical and digital products and services.
Examples
Retail Store (Physical Products): Clothing, accessories, shoes. The cost of the fabric and labor to make the clothes would be COGS. The cost of the shoes they pay to then sell them, would also be COGS.
 Course Creator (Digital Service/Product): Online courses, digital guides, membership subscriptions. The cost for video production, course platform fees, and any software used for creating the course would be COGS.
Consulting Firm (Service-Based): Business consulting, financial planning, financial advice. The cost of software and freelancers (also referred to as contractors), would be COGS.
Goods refer to both physical and digital products and services.
Types of COGS (using a kitchen remodeling business as an example)
Job materials (lumber, nails)
Wholesale purchase costs (cabinets before they are installed)
Contractors (installers)
Shipping costs (cost of shipping cabinets)
COGS are deductions on tax returns.
Why COGS (Cost of Goods Sold) Matter
They matter because these expenses factor into the equation of seeing how much gross profit you have before you subtract operating expenses. They are also deductions which offsets the amount of money you would owe for taxes.
There are other reasons you would want to review these particular costs and analyze the numbers. Are you spending too much on products you sell? Could you find a better manufacturer to purchase from? Are your contractors costing you too much? Perhaps you are not charging enough to make a profit?
Perhaps you are not charging enough to make a profit?
Common Mistakes
Putting contractors in operating expenses
Not putting vendor names in the expenses so that when you review contractors, you cannot see the total you paid to a specific person to determine whether they need a 1099 form or not
Confusing job materials for the business with job materials for a project
Final Thoughts
Understanding COGS (Cost of Goods Sold) is important to have accurate bookkeeping records and to be able to analyze your business effectively.
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