If you run a small business — even a simple shop or home-based manufacturing setup — one question always comes up:
“How much did it actually cost me to sell this product?”
That exact answer comes from something called Cost of Goods Sold (COGS).
Understanding COGS helps you see your real profit, not just your sales numbers. For beginners learning accounting or business basics in India, this is one of the most important concepts to understand early.
What is Cost of Goods Sold (COGS)?
Let’s start with a simple situation.
Imagine you sell wooden study tables. A customer pays you ₹5,000 for one table. But before you celebrate the sale, think about what you spent to make it — wood, carpenter wages, and factory electricity used during production.
All these direct costs together are called Cost of Goods Sold (COGS).
In simple words:
COGS is the total cost directly spent to make or buy the products that you actually sold during a period.
It focuses only on costs connected directly to production.
What counts as COGS?
Usually, it includes:
- Raw materials (like wood, fabric, steel, ingredients)
- Direct labour (workers who make the product)
- Factory-related production costs (machine power, production utilities, etc.)
If the product would not exist without that expense, it normally belongs inside COGS.
Why COGS Matters for Beginners and Businesses
Many beginners look only at sales revenue and assume higher sales mean higher profit. In practice, that is rarely true.
COGS helps you calculate gross profit, which shows whether your business is actually earning money from selling products.
How it works:
Sales Revenue − Cost of Goods Sold = Gross Profit
Let’s see a simple Indian example:
| Item | Amount |
|---|---|
| Sales from tables | ₹5,00,000 |
| Cost to produce tables (COGS) | ₹3,20,000 |
| Gross Profit | ₹1,80,000 |
This ₹1,80,000 is what remains to pay rent, marketing, salaries, and other business expenses.
From practical experience, many small business owners realise late that high sales don’t help if production costs are also rising. COGS helps you notice this early.
What COGS Does NOT Include (Very Important)
This part often confuses beginners.
COGS only includes production-related costs, not general business expenses.
For example, these are not part of COGS:
- Office rent
- Advertising expenses
- Owner or management salaries
- Sales team expenses
- Marketing costs
These are called operating expenses and appear separately in financial statements.
A simple way to think about it:
Ask yourself — “If I made zero sales this month, would this expense still exist?”
If yes, it usually is not COGS.
The Purpose of Calculating COGS
Businesses calculate COGS mainly to understand the true cost of goods that were actually sold, not just produced or purchased.
Suppose a clothing shop buys 1,000 shirts but sells only 600 during the year. The cost of the remaining 400 shirts is not counted yet. Those stay as inventory.
This helps business owners and investors understand performance correctly instead of mixing sold and unsold stock costs.
Simple COGS Formula
COGS is calculated using inventory movement.
Instead of complicated wording, think of it like this:
You start the year with some stock.
You buy or produce more during the year.
Some items remain unsold at the end.
So the cost of goods sold equals:
Opening Stock + Purchases or Production − Unsold Stock
Example
- Opening inventory: ₹1,00,000
- Purchases during year: ₹4,00,000
- Closing inventory: ₹1,50,000
COGS becomes:
₹1,00,000 + ₹4,00,000 − ₹1,50,000 = ₹3,50,000
This means goods costing ₹3,50,000 were actually sold.
How Inventory Method Changes COGS
Here is something beginners don’t notice initially — the way inventory is valued changes the COGS number.
Let’s imagine raw material prices keep increasing (which is common in India).
1.FIFO (First-In, First-Out)
The oldest stock is assumed to be sold first.
In rising prices, older goods are cheaper.
So COGS appears lower and profit looks higher.
Many businesses find this method easier to understand because it follows natural stock movement.
2.LIFO (Last-In, First-Out)
The newest stock is assumed to be sold first.
Since newer goods cost more during inflation, COGS becomes higher and profit appears lower.
3.Average Cost Method
Instead of tracking batches separately, businesses calculate an average cost per unit and apply it to all sales.
This method smooths price fluctuations and is often easier for regular inventory businesses.
4.Specific Identification Method
Used when every item is unique — like cars, real estate units, or expensive jewellery — where each item’s exact cost is known.
Understanding Cost of Goods Manufactured (COGM)
If you run a manufacturing business, there is one more step before COGS called Cost of Goods Manufactured (COGM).
Think of it this way:
- COGM tells you how much it cost to produce goods during the period.
- COGS tells you how much of those produced goods were actually sold.
COGM includes:
- Direct materials used
- Direct labour
- Manufacturing overhead
- Adjustment for unfinished goods in production
Example
A furniture factory spends:
- Materials: ₹10,00,000
- Labour: ₹5,00,000
- Factory overhead: ₹6,00,000
- After adjusting unfinished production, total manufacturing cost becomes ₹19,00,000.
That becomes the production cost transferred into finished goods inventory, which later helps calculate COGS.
Why Businesses Closely Monitor COGS
In real business situations, small changes in production cost can strongly affect profit.
Consider two companies:
| Company | Sales | COGS | Result |
|---|---|---|---|
| A | ₹10,00,000 | ₹7,50,000 | Lower profit margin |
| B | ₹8,00,000 | ₹4,00,000 | Higher profit margin |
Even with lower sales, Company B earns better because production costs are controlled.
Many beginners assume growth means selling more. Experienced business owners often focus instead on managing costs efficiently.
COGS vs Operating Expenses (Easy Difference)
| Basis | COGS | Operating Expenses |
|---|---|---|
| Related to production | Yes | No |
| Needed to create product | Yes | Not directly |
| Example | Raw materials | Marketing |
| Position in income statement | Before gross profit | After gross profit |
Understanding this separation helps you read financial statements confidently.
Service Businesses and COGS
Not every business uses COGS.
Pure service providers — like consultants, lawyers, or accountants — usually do not sell physical products. Since they don’t maintain inventory, they normally don’t calculate COGS.
Instead, they track service-related costs separately.
A Simple View
If you sell a chair for ₹2,000 and it costs ₹1,200 to make it, then:
₹1,200 is your Cost of Goods Sold.
It includes only what was needed to make the chair — not your shop rent or advertising.
Conclusion
Cost of Goods Sold is simply the real cost behind the products you sell. It helps you move from “sales excitement” to “profit understanding.” Once you understand COGS, financial statements start making much more sense because you can clearly see how efficiently a business produces and sells its goods.
FAQs About Cost of Goods Sold (COGS)
If you’re learning accounting or business basics for the first time, it’s completely normal to have questions about Cost of Goods Sold (COGS). Below are answers to some of the most common beginner questions — along with deeper practical doubts that usually come up once you start applying the concept in real life.
What is Cost of Goods Sold (COGS) in simple words?
Cost of Goods Sold means the direct cost spent to make or buy the products that you actually sold. It includes things like raw materials and worker wages used in production. For example, if you sell handmade candles, wax and labour costs become part of COGS.
Why is COGS important for small businesses in India?
COGS helps you understand your real profit instead of just looking at sales. Many small shop owners see high revenue but low savings because production costs are also high. Knowing COGS helps you see whether your pricing and production costs are balanced.
Is COGS the same as business expenses?
No, they are different. COGS includes only production-related costs, while business expenses include rent, marketing, office salaries, and similar costs. These general expenses happen even if no product is sold.
Does COGS include employee salaries?
Only salaries directly connected to making the product are included. For example, a carpenter building furniture counts under COGS, but an office manager’s salary does not. The key idea is whether the work directly creates the product being sold.
How is COGS different from operating expenses?
COGS relates to producing goods, while operating expenses relate to running the business overall. Electricity used in a factory may be part of COGS, but electricity used in the office usually falls under operating expenses.
Can service businesses calculate COGS?
Pure service businesses usually don’t calculate COGS because they don’t sell physical goods or maintain inventory. Instead, they track service-related costs separately. However, service businesses that also sell products — like hotels selling food — may still calculate COGS for those items.
What is the difference between COGS and Cost of Goods Manufactured (COGM)?
COGM measures how much it cost to produce goods during a period, while COGS measures the cost of goods that were actually sold. Think of COGM as production cost and COGS as sold-product cost.
