Definition:

Cost of Goods Sold (COGS) refers to the direct costs attributable to the production of the goods sold by a company. This amount includes the cost of the materials and labor directly used to create the product.

Examples

For a bakery, COGS would include the cost of flour, sugar, eggs, and labor used to bake bread. For a car manufacturer, COGS would include the cost of steel, tires, and assembly line labor.

Formula:

COGS = Beginning Inventory + Purchases During the Period - Ending Inventory

How to use the metric:

COGS is used to determine a company's gross profit by subtracting it from total revenue. It helps in assessing the efficiency of production and inventory management. Lower COGS can indicate better cost control and higher profitability.

Limitations:

COGS does not include indirect costs such as distribution and sales expenses. It can also be manipulated through inventory accounting methods like LIFO or FIFO, which may not accurately reflect current costs.

Applies to:

COGS is applicable to manufacturing, retail, and wholesale industries where physical goods are produced or sold.

Doesn't apply to:

COGS does not apply to service industries where there are no tangible goods produced. In such cases, the equivalent metric would be the cost of services rendered.

Summary:

COGS is a crucial financial metric that helps businesses understand the direct costs involved in producing goods. It is essential for calculating gross profit and assessing production efficiency, though it has limitations in terms of indirect costs and accounting methods.