COGS (Cost of Goods Sold) Explained: What It Is, How It’s Calculated & Examples

Why did you get into business? If you’re like most of our customers, it’s because you were passionate about creating something delicious, something healthy, or you’re in love with being an entrepreneur.

But at the end of the day you started a business – and a business needs to be profitable. To do that, you need to understand your financial metrics.

One essential metric is COGS – Cost of Goods Sold. It’s not just a bunch of letters; it’s a key to deciphering the financial health of your enterprise. 

In this post, we define what COGS is, how it’s calculated, and how it can be a guiding light for your business success.

What Does COGS Stand For?

COGS stands for Cost of Goods Sold. It’s the sum of all the direct costs that go into producing the goods your business sells. Consider it the backstage pass to your product’s journey – from raw materials to finished goods. 

The metric serves as a cornerstone for understanding your production costs and ultimately, your profitability.

What’s Included in the Cost of Goods Sold?


The cost of raw materials and components used to create your product forms a significant chunk of COGS. From the paper in packaging to the ink that adorns it, every element adds to the melody.


Labor, or your employees, are the next component of COGS. Their wages, benefits, and even the time they invest in crafting the final product, all contribute to the COGS calculation. Every employee contributes to your product.


Operations costs include expenses related to the facilities, utilities, equipment, and other essential elements that ensure your production line runs smoothly. Like a symphony hall needs maintenance, your operations need to be finely tuned.

Cost of Goods Sold Formula

The heart of COGS lies in its formula – a straightforward yet revealing equation that offers insights into your business’s financial soul. 

COGS is calculated by subtracting the beginning inventory from the sum of purchases and other costs incurred during a specific period. The formula acts as a compass, pointing you toward the direction of your business’s production efficiency.

How to Calculate Cost of Goods Sold

Calculating COGS isn’t rocket science, but it’s a pivotal step in understanding your business’s financial landscape. Start with your beginning inventory – the value of goods you had on hand at the beginning of the period. 

Add your purchases during that period, and then factor in any additional costs directly related to production. Finally, subtract the ending inventory from this sum. Voila! You have your COGS for the period.

Examples of COGS

Imagine you run a chocolate chip cookie business. Let’s say you start the year with $50,000 worth of ingredients: flour, sugar, baking soda, salt, eggs. Throughout the year, you purchase $100,000 more ingredients, and your ending inventory is valued at $30,000. Using the COGS formula, your COGS for the year would be ($50,000 + $100,000) – $30,000 = $120,000. This amount represents the direct costs incurred to produce your delicious cookies.

Benefits of COGS

Understanding your COGS isn’t just about crunching numbers; it’s about making informed decisions. By dissecting your production costs, you gain insights into the efficiency of your operations. 

This knowledge can guide you in pricing your products, optimizing your production processes, and identifying areas where cost savings can be achieved.

How to Use COGS for Your Business

As you navigate the retail landscape, COGS becomes your compass for strategic decisions. Here’s how you can leverage COGS insights to steer your business toward success:

Pricing Mastery: With COGS knowledge, you’re equipped to set prices that not only cover costs but also leave room for profit. You’ll strike the balance between affordability and profitability.

Inventory Management: Understanding COGS aids in managing your inventory efficiently. It helps prevent overstocking, reduce carrying costs, and ensure that you always have the right amount of products in stock.

Profitability Planning: COGS insights can guide your profitability targets. By fine-tuning your production processes and reducing costs, you can drive your business’s profitability higher.

Performance Tracking: Regularly tracking COGS allows you to spot trends and anomalies. This proactive approach helps you address issues promptly and seize opportunities for growth.

In the grand symphony of business, COGS plays a vital note that resonates throughout your financial composition. Like a conductor shaping an orchestra’s performance, understanding COGS empowers you to make harmonious decisions that lead to a crescendo of success.

Wrapping Up

As we draw the curtain on our exploration of COGS, remember this: beneath every product lies an array of costs, a composition of materials, labor, and operations. COGS gives you the lens to view this composition, to unravel its complexities, and to use this knowledge to craft a path to profitability.

With every product you bring to market, you’re composing a unique piece, blending creativity and financial acumen. Let COGS be your guiding framework, helping you strike the perfect balance between creation and sustainability.

So, as you journey forward in the world of chocolate chip cookie production or any consumer goods endeavor, remember the power of COGS. It’s not just a figure on a spreadsheet; it’s a powerful provider of insights that can transform your business’s passion into a resounding success.

Are you ready to step confidently into this arena, armed with the knowledge of COGS? With this compass, your business journey becomes a thrilling performance, a masterpiece in the making. As you embrace the practicality of numbers and the inspiration of possibilities, you’ll see your dreams take shape, one COGS-driven decision at a time.