Whether you're a small e-commerce business owner or leveling up to take on the big-name competition, you need accurate cost information to protect your profits. So, what is COGS, and why does it matter so much? Cost of goods sold (COGS, or cost of sales) is an important metric for sales, inventory, and accounting teams alike.
As you scale up your business and explore new markets, increasing costs might weigh you down and hurt your cash flow. However, if you try to cut expenditures without using inventory data, you might damage your growth potential.
That's where we come in: with Cin7, you can calculate COGS in real time as your business grows.
So what is COGS in the first place?
COGS is the direct cost of the products you sold during a period. You figure it as beginning inventory plus purchases minus ending inventory. It's often the second line on your income statement, right after revenue, and you subtract it from revenue to get gross profit.
It's similar to the cost of goods manufactured (COGM), which accounts for the cost of sold and unsold products you produce. COGS only counts what actually left the building.
Here's the short version: if a cost goes directly into making or buying the products you sell, it's probably COGS. If it keeps the lights on in the office or brings customers through the door, it isn't.
| Included in COGS | Excluded from COGS |
|---|---|
| Raw materials (e.g., wood, varnish) | Marketing and advertising |
| Finished goods bought for resale | General and administrative expenses (e.g., office supplies) |
| Direct labor for production | Office rent |
| Production overhead (e.g., factory utilities, equipment depreciation) | Distribution salaries |
| Freight-in (shipping costs to get inventory to you) | Sales salaries |
| Packaging | Management salaries |
One heads-up on labor. The IRS notes in Publication 334 that labor costs are usually part of COGS only in a manufacturing or mining business. If you're a small retailer or wholesaler, you likely won't have any.
To calculate COGS, you need to know your beginning inventory and ending inventory. Your beginning inventory is your stock at the start of the accounting period. Your ending inventory is simply the stock left over at the end of it.
Here's how purchases, beginning inventory, and ending inventory fit into the COGS formula:
Beginning Inventory + Purchases − Ending Inventory = COGS
"Purchases" means every direct cost you added during the period. For a reseller, that's the goods you bought. For a manufacturer, it also covers materials, direct labor, and production overhead.
Let's put some (made-up) numbers on a small business that builds coffee tables. Here's one quarter:
| Line item | Amount |
|---|---|
| Beginning inventory (wood, varnish, finished tables on hand) | $2,000 |
| Purchases (materials, hardware, freight-in) | $5,500 |
| Ending inventory | $1,500 |
| COGS ($2,000 + $5,500 − $1,500) | $6,000 |
| Revenue (25 tables at $600) | $15,000 |
| Gross profit (Revenue − COGS) | $9,000 |
| COGS as a percentage of revenue ($6,000 ÷ $15,000) | 40% |
So, for every dollar of tables you sell, 40 cents covers what went into them. The other 60 cents is gross profit to pay for everything else (and, hopefully, you).
Want more practice? Our guide to the COGS formula walks through extra examples.
If you monitor your COGS as your business grows, you might notice that it increases as your business processes become more complex.
Your accountants need COGS for your company's income statement. Two common accounting methods related to COGS are first in, first out (FIFO) and last in, first out (LIFO).
However, COGS calculations are useful for more than just preparing financial statements and keeping the IRS happy. COGS drives your gross margin, so it tells you whether your prices actually cover your costs. Raise prices without knowing your COGS, and you're guessing.
COGS also matters at tax time. Per IRS Publication 334, US businesses filing Schedule C that make or buy goods to sell can deduct COGS from gross receipts.
And as you add more distribution channels, COGS can highlight inventory weak points. That helps you control business expenses without hurting your bottom line.
So what's the best way to tie COGS into your inventory management approach? It helps to use an IMS like Cin7, which gives you accurate job costing and lets you continuously calculate COGS. You get a real-time snapshot of your company's financial health and the data to make better purchasing decisions.
By leveraging Connected Inventory Performance from Cin7, you can save your accountants or bookkeepers time and effort tracking down your direct costs.
Honestly? It depends on what you sell. A grocery maker and a fashion brand live in very different worlds.
For context, here are January 2026 averages for large US public companies from NYU Stern professor Aswath Damodaran's margins dataset:
| Industry (US public companies) | COGS as % of sales | Gross margin |
|---|---|---|
| Retail (General) | 66.82% | 33.18% |
| Apparel | 43.12% | 56.88% |
| Food Processing | 76.77% | 23.23% |
Keep in mind these are big, listed companies with serious buying power. They're useful for spotting how your industry tends to run, but they aren't targets for a small or private business. Your best benchmark is your own COGS percentage, tracked over time.
The method you use to value inventory changes your COGS, especially when supplier prices are climbing. Here's how the four main options compare.
For a deeper dive, see our breakdown of FIFO vs. LIFO inventory valuation.
FIFO assumes you sell your oldest stock first. When costs rise, those older, cheaper units hit COGS first, so COGS stays lower and gross profit looks higher.
LIFO assumes you sell your newest stock first. When costs rise, COGS goes up and reported profit goes down.
Selling internationally? KPMG writes that IAS 2 prohibits LIFO under IFRS, while US GAAP allows it.
Weighted average spreads your total inventory cost evenly across every unit. When costs rise, COGS lands between FIFO and LIFO, which smooths out price swings.
Specific identification tracks the actual cost of each individual item you sell. It's a natural fit for one-of-a-kind products, like a bespoke coffee table. COGS reflects exactly what that item cost, whether prices are rising or not.
These three get mixed up a lot. Here's how they stack up:
| Term | What it covers | Where it shows up |
|---|---|---|
| COGS | Direct costs of the products you sold | Income statement, right below revenue |
| Cost of revenue | COGS plus other direct costs of delivering a sale, often used by service or subscription companies | Income statement, in place of COGS |
| Operating expenses (OpEx) | Costs of running the business, like marketing, rent, and admin salaries | Income statement, below gross profit |
So, does COGS go under revenue? Yep! Revenue comes first, then COGS, and the difference is your gross profit.
Operating expenses come out after that, leaving your operating profit.
We'll walk you through the four stages of business growth: Beyond Basics, Unifying Operations, Scaling Up, and Sustaining Success. But first, let's look at COGS for a brand-new business.
Say you start a small business from your garage, making bespoke coffee tables using your woodworking expertise. You already own the equipment needed, so your only costs are materials like wood and varnish.
You might buy leftover wood from a local furniture factory's production to reduce costs and purchase varnish on clearance from your local hardware store. Since you don't pay yourself a wage, you have no direct labor costs. Instead, COGS is the wood and varnish used for each table.
Once it's a viable business (not just selling to friends and relatives), you move on to the first growth stage: Beyond Basics.
At this stage, your business has a solid customer base, but there is plenty of room for sales growth.
You'll want to add new product lines, hire staff, and find an alternative to manual inventory processes. Plus, manual data entry and reporting are starting to waste time and cause inventory inefficiency.
Let's go back to your woodworking startup to see how exactly COGS fits into Beyond Basics.
Your business has picked up, and you're producing tables at capacity. After all, your garage only has one woodworking machine and limited storage space.
Through careful planning, you've created a production schedule that efficiently uses your time and resources. Instead of long evenings spent woodworking, you have extra time for marketing and networking.
You've grown enough that the local furniture factory owner recognizes you as a competitor, so you need a new direct materials supplier for wood. Your COGS will likely change as you transition to buying wood on the open market.
On the open market, you have a much better choice of quality materials like wood, and you're building strong relationships with suppliers.
You've started to better organize your workflow by using spreadsheets for order tracking, stock counts, and accounting tasks. But you're struggling to connect everything together correctly and make money.
All this manual inventory admin leaves less time for production, so you hire a friend to help with manufacturing. It's great to have help, but this new employee needs a part-time or full-time wage, which means your COGS takes a hit.
If you can keep your business operating without losing focus on key processes, such as manufacturing and selling, you'll move on to the next stage.
What to track in COGS at this stage: material cost per table from your new suppliers, plus your first direct labor costs.
In the Unifying Operations stage, businesses take on even more employees, increase product lines, and move into new sales channels. This is great for growth potential, but some new challenges affect COGS, such as:
So, how does COGS change during the Unifying Operations stage? Let's have a look through the lens of our woodworking startup.
You've rented a retail storefront with a large workshop in the back, purchased new equipment, and hired more staff. They help you assemble and ship your expanding product offerings (e.g., tables, chairs, and stools) to customers.
You've ramped up production to fulfill orders from new sales channels. Now you need to make sure you don't overproduce and wipe out your profits.
Crunching the numbers on COGS manually, optimizing your production process, and looking for bulk discounts with suppliers can become a time-consuming task.
Instead of personally delivering furniture or using a costly courier, you might also contract a third-party logistics company to help.
With so many new processes, how do you truly unify your company's head-spinning operations and keep COGS and other operating expenses as low as possible?
Moving away from manual processes with inventory management software like Cin7 Core or Omni helps you:
What to track in COGS at this stage: labor, warehousing, waste, and return costs, broken out by sales channel.
While business growth is steady during Unifying Operations, it's just the foundation for your next business stage. In the Scaling Up stage of business growth, product businesses explore new partnerships and keep diversifying their sales channels. However, these growth spurts add complexity and increase COGS with:
So, can your woodworking business rise to meet the challenge while controlling COGS?
You'll need to continually run COGS, inventory, and sales reports to make sure you're operating at a profit. By getting rapid COGS calculations from your inventory management software, you can:
With chairs, stools, and tables all sharing the same lumber, bill of materials (BOM) management helps you see exactly what each product costs to make.
If you can scale up comfortably and use every resource to maintain momentum, you'll be ready to shift strategy in your next growth stage.
What to track in COGS at this stage: raw material costs against sale prices, plus the cost of manufacturing errors and dead stock.
In the Sustaining Success stage, businesses are making money and have reached a period of stability. Some key concerns in this stage are:
To stay in the Sustaining Success stage, you'll need a strong awareness of COGS.
If you monitor COGS continually with inventory management software, you can make small but decisive changes that keep your business financially healthy.
What to track in COGS at this stage: small shifts in your COGS percentage that hint at hidden inefficiencies.
Cutting COGS doesn't mean buying cheaper wood and hoping nobody notices. These levers lower costs while keeping quality (and growth) on track.
Once you know your volumes, you've got leverage. Ask for bulk discounts or better payment terms, and use purchase order management to track what each supplier actually charges you.
Every unit you overbuy ties up cash and risks becoming dead stock. Better demand forecasting helps you buy what you'll actually sell.
Offcuts, damaged goods, and slow sellers all quietly inflate COGS. Review slow-moving products regularly, then discount, bundle, or discontinue them before they gather dust.
Manual data entry eats hours and invites errors that throw off your costs. If you're ready to move off spreadsheets, automation keeps your COGS numbers current without the busywork.
Your real product cost is the supplier's invoice plus freight, duties, and fees. Tracking those helps you manage tariff impact on landed costs and price with confidence.
Play Pits knows these levers well. The team ran on spreadsheets and calculated landed costs by hand. Reconciliation took three to four weeks each month.
With Cin7 and Fiskal Finance working together, Play Pits freed up more than 15 hours a week from manual costing and PO matching.
Month-end close went from a monthlong scramble to the same week. Now that's a cost cut nobody complains about!
COGS is an expense, so it normally goes up with a debit. When you sell a product, you debit COGS and credit inventory for what that item cost you. In plain terms, the cost leaves your shelves and lands on your income statement.
COGS drops when you sell fewer units or each unit costs less to make or buy. Lower supplier prices, bulk discounts, cheaper freight-in, and less waste all pull it down. Your costing method matters too: when prices are rising, FIFO usually reports lower COGS than LIFO. Just remember that a drop caused by slower sales isn't a win!
There's no official rulebook here, but it's common to split COGS by business model. Merchandising COGS applies to businesses that resell finished goods, so it's mostly the purchase price plus freight-in. Manufacturing COGS applies to businesses that make their products, adding raw materials, direct labor, and production overhead. The IRS notes in Publication 334 that labor is usually part of COGS only in manufacturing or mining.
It depends on your industry. Among large US public companies (January 2026), NYU Stern's Aswath Damodaran puts apparel COGS at 43.12% of sales and general retail at 66.82%. So 50% would run high for a big apparel brand but low for a general retailer. Those are averages for listed giants, though, so your best benchmark is your own COGS percentage over time.
Only some of them. Wages for people who directly make your products, like the friend you hire to help build tables, count as direct labor in COGS. Admin, sales, and management salaries don't; they're operating expenses. Corporate Finance Institute also lists management salaries among the selling expenses COGS leaves out.
Cin7 is an IMS (inventory management system) built for product businesses at every growth stage. Our advanced reporting and analytics feature includes 100+ customizable reports. You can bring together inventory and sales data to see what your COGS means at every stage.
In addition to inventory cost accuracy and seamless integrations, Cin7 automates every part of your inventory life cycle. That helps you avoid manual COGS calculations and break free from your inventory shackles.
This way, you can stay focused on overcoming the challenges of moving through different business stages.
Sign up for a free trial today to see how Connected Inventory Performance clears your inventory to-do list. Then get back to growing your business!
Prefer a guided tour? Get a demo and we'll show you how Cin7 keeps your COGS accurate from garage to growth.