Cost of goods sold, usually shortened to COGS, is what you paid for the products you sold during a period. It's the first cost subtracted from your sales on a profit and loss statement, and what's left is your gross profit.
If COGS is wrong, everything below it is wrong too. A restaurant with invoices recorded in the wrong month can look like it has a food cost problem, and a gas station that mixes fuel purchases with store supplies can't see its real fuel margin. Getting COGS right is mostly about recording costs in the right account and at the right time.
What cost of goods sold includes
COGS covers the direct cost of what you sell. Depending on the business, that includes:
- The cost of products bought for resale
- Raw materials and ingredients that go into what you make
- Freight and delivery charges to get inventory to you
- Packaging that is part of the product
- Direct labor for production, for businesses that make what they sell
What it doesn't include
Costs of running the business that would exist even if you sold nothing are operating expenses, not COGS. These include:
- Rent and utilities
- Office and administrative salaries
- Advertising and marketing
- Software, insurance and professional fees
A service business with no inventory may have little or no cost of goods sold at all.
How to calculate cost of goods sold
For a business that holds inventory, the formula is:
- Start with the value of your inventory at the beginning of the period.
- Add the inventory you bought during the period.
- Subtract the value of your inventory at the end of the period.
What's left is the cost of what you sold. Here's an example for a convenience store over one month:
| Item | Amount |
|---|---|
| Beginning inventory | $30,000 |
| Plus purchases | $45,000 |
| Minus ending inventory | $28,000 |
| Cost of goods sold | $47,000 |
The ending inventory figure comes from a physical count or from your inventory system. If nobody counts, the COGS number is a guess.
Cost of goods sold and gross profit
Gross profit is sales minus cost of goods sold. Divided by sales, it gives your gross margin, which tells you how much of each sales dollar is left to pay for everything else.
| Item | Amount |
|---|---|
| Sales | $70,000 |
| Cost of goods sold | $47,000 |
| Gross profit | $23,000 |
Watching gross margin month to month is one of the fastest ways to spot a problem, such as a supplier price increase, theft or waste, or prices that haven't kept up with costs. For more on reading the whole report, see how to read a profit and loss statement.
How to track cost of goods sold in QuickBooks Online
QuickBooks Online has a separate account type called Cost of Goods Sold. How you use it depends on whether you track inventory in QuickBooks.
If you track inventory in QuickBooks
On the Plus and Advanced plans, you can set up inventory items with a quantity and a cost. When you buy them, they go into an inventory asset account. When you sell them, QuickBooks moves their cost into cost of goods sold automatically, using the first in, first out method.
If you don't track inventory in QuickBooks
Many restaurants and small retailers don't track each item. Instead, they record purchases straight to cost of goods sold accounts, then adjust for the change in inventory after each count with a journal entry. It's simpler, and it works well as long as the counts happen regularly.
Set up separate COGS accounts
Either way, split COGS to match how you split sales. A restaurant might use food cost and beverage cost; a gas station might use fuel cost and store merchandise cost. That way each product line shows its own margin. My guide to the chart of accounts shows how this fits into the full list of accounts.
Common cost of goods sold mistakes
- Recording supplier invoices when they're paid instead of when the goods arrive, which shifts costs between months
- Putting supplies, rent or wages that aren't direct costs into COGS
- Never counting inventory, so COGS includes stock still sitting on the shelf
- One COGS account for everything, so you can't see which products make money
- Forgetting freight on incoming inventory
Want your cost of goods sold set up right?
I've spent 38 years in accounting, and I've worked with restaurants, gas stations and other businesses where margins depend on getting COGS right. I work with small businesses online from Weatherford, Texas. See my QuickBooks services or book a short intro call.