What Is Cost of Goods Sold (COGS)?

COGS appears directly below revenue on the income statement, and Revenue − COGS = Gross Profit, the starting point for measuring how efficiently a company turns sales into margin before overhead is factored in. For a product business, COGS includes raw materials, factory labor, and shipping to get the product ready for sale. For a service business, it typically includes the direct labor cost of delivering the service (e.g., a consultant's billable hours), though many service companies track this less rigorously than product companies do.

What counts as COGS versus operating expense matters for accurate margin analysis: rent on a factory is COGS, rent on a corporate office is not; a customer support rep answering post-sale tickets is typically an operating expense, while a technician installing the product is often COGS. Getting this classification consistent matters for comparing gross margin over time and against industry benchmarks.

Misclassifying costs between COGS and operating expenses distorts gross margin — the metric investors and lenders use to judge whether a business model is fundamentally sound before overhead is even considered. An accountant or bookkeeper can set up a chart of accounts that classifies costs correctly from day one, so margin reporting is accurate and comparable as the business scales.