The cost of sales and cost of goods sold (COGS) are crucial when analyzing whether a business is profitable. However, companies often list COGS or cost of sales (and sometimes both) on their income statements, leading to confusion about what they mean. Fortunately, for those confused, there is almost no difference between COGS and cost of sales in practical terms. In accounting, they are often used interchangeably.
The cost of sales (also known as the cost of revenue) and COGS track the cost of producing a good or service. These costs include labor, raw materials, and overhead directly tied to production.
Key Takeaways
- The cost of sales and the cost of goods sold (COGS) measure what a business spends to produce a good or service.
- The terms are practically interchangeable and include the cost of labor, raw materials, and other overhead for running a production facility or providing a service.
- Service providers such as attorneys use cost of sales since service-only businesses can't list tangible items as operating expenses. Manufacturers like auto parts makers use COGS.
- Both terms are key for measuring profitability. Higher costs with flat revenue could mean costs are poorly managed, while higher costs and higher revenue, or flat costs and higher revenue, can suggest a company is managing its costs well.
Cost of Goods Sold (COGS)
COGS tracks the direct costs tied to the production of a company's goods. This includes the materials and labor directly used to create the product but excludes indirect expenses such as marketing, distribution, and sales.
For example, a manufacturer like a toy company would have COGS that include the cost of plastic and other materials used in manufacturing, as well as the wages of factory workers.
The formula for calculating COGS
Here is the basic formula to calculate COGS:
COGS = Beginning Inventory + Purchases During the Period − Ending Inventory
Cost of Sales
Cost of sales, or cost of revenue, comprises the direct costs of producing the goods or services that a company sells. The slight difference between the cost of sales and COGS is that it also includes the costs of services provided, making it more relevant to service-oriented businesses. A consultancy, for instance, would have the cost of sales that might consist of the salary of consultants and direct expenses to provide their services, such as travel when visiting clients.
Cost of sales example
Below is taken from the earnings report of Ford Motor Company (F) from the fourth quarter of 2023. It supplied its cost of sales over three years. Because Ford is both a car company and issues loans through Ford Credit, it manufactures goods and has costs for services. It notes that its cost of sales excludes selling and administrative costs but does include expenses "related to the development, production, and distribution of our vehicles, parts, accessories, and services. Specifically, we include in the cost of sales, material costs (including commodity costs), freight costs; warranty, including product recall costs; labor and other costs related to the development and production of our vehicles and connectivity, parts, accessories, and services; depreciation and amortization; and other associated costs."
:max_bytes(150000):strip_icc()/FordQ4-8dd41927f91b4000939c371d826f5d71.jpeg "How Are Cost of Goods Sold and Cost of Sales Different? (1)")
When To Use COGS vs. Cost of Sales
| COGS vs. Cost of Sales | ||
|---|---|---|
| Feature | COGS | Cost of Sales |
| Applicability | Manufacturing, industrial, & trading companies | Service-oriented businesses |
| Includes | Direct material and labor | Direct cost of providing services |
| Example | Raw materials and factory labor | Salaries of service personnel and business travel expenses |
Although COGS and cost of sales are similar, they serve different types of businesses. COGS is primarily used by manufacturing and industrial companies that have tangible products. At the same time, cost of sales is more relevant to service-oriented companies and retailers who sell products made by other manufacturers. (As a mnemonic, COGS has "g" for goods in it.)
Because service-only businesses don't base operating expenses on tangible goods, they cannot list COGS on their income statements.Instead,they list the cost of sales or revenue. Examples of businesses that would do so are attorneys, business consultants, and doctors.
Some service providers, however, also offer secondary products to customers. Airlines provide food and beverages to passengers, and hotels might sellsouvenirs and spa products. As goods, these costs can be listed under COGS.
Why the Cost of Sales and COGS Matter
Cost of sales and COGS are key metrics in analyzing business profitability. They are subtracted from total revenue, yielding gross profit. Both show the operation costs involved in producing goods or services. If these costs are rising while revenue isn't, this could indicate thatdirectcosts are not being managed properly.
Companies that offergoods and services are likely to have both COGS and cost of sales on their income statements.
How Do COGS and Cost of Sales Impact Profitability?
Both COGS and cost of sales directly affect a company's gross profit. Gross profit is calculated by subtracting either COGS or cost of sales from the total revenue. A lower COGS or cost of sales suggests more efficiency and potentially higher profitability since the company is effectively managing its production or service delivery costs. Conversely, if these costs rise without an increase in sales, it could signal reduced profitability, perhaps from rising material costs or inefficient production processes.
Can COGS and Cost of Sales Affect Prices?
Yes, COGS and the cost of sales can influence prices. Businesses must understand their direct costs to set prices that cover them while keeping to price points that maintain competitiveness and ensure a profit. If COGS or the cost of sales increases without adjusting prices, the company might face reduced margins. Therefore, companies often review these costs regularly to make informed pricing decisions, ensuring they align with market conditions and business objectives.
How Do Inventory Management Practices Affect COGS?
Effective inventory management is crucial in controlling and predicting COGS. Practices such as just-in-time inventory management can cut holding costs and minimize waste, directly affecting COGS by lowering the amount of capital held up in unsold stock. Conversely, poor inventory management can lead to overstocking or stockouts, which can increase holding costs or cause missed sales.
Where Can I Find a Company's COGS or Cost of Sales?
Cost of sales or COGS are typically found in a company's income statement, a required financial document that summarizes the company's revenues, expenses, and profits over a specific period, usually a quarter or a year. The income statement starts with the company's total revenue or sales for the period. Then, COGS is subtracted from this total revenue to calculate the gross profit.
The Bottom Line
While they can be treated the same, there is a difference between COGS and cost of sales. While both terms essentially track the direct costs faced by a company, their application depends on the industry and the nature of the business. COGS is commonly used by manufacturing and goods-based companies to reflect the direct production costs, such as raw materials and labor. Meanwhile, the cost of sales is more applicable to service-oriented or retail businesses, covering costs directly tied to the provision of services, including labor and overhead. Both numbers are important in calculating a company's gross profit, which is found by subtracting these costs from total revenue.
Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy.
I. Basioudis."Financial Accounting: The Basics." Taylor & Francis Group, 2019. Pages 180-182.
Ford Motor Company. "Earnings Report (10K)." Page 42.
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