COGS

Cost of goods sold; direct costs of producing the goods or services sold.

Cost of Goods Sold (COGS) represents the direct costs associated with producing the goods or services sold by a company. This metric includes expenses directly tied to production, such as raw materials, direct labor costs, and manufacturing overhead. It excludes indirect expenses, such as distribution costs, sales force salaries, and marketing expenses, which are categorized under operating expenses. Investors observe COGS on the income statement, where it is subtracted directly from total revenue to calculate a company's gross profit. Because COGS is the primary expense for many manufacturing, retail, and product-based businesses, tracking how it changes relative to revenue is critical for understanding production efficiency and pricing power. Analyzing COGS helps investors evaluate a company's operational health. A rising COGS relative to sales can indicate that raw material costs are increasing or production efficiency is declining, which squeezes profit margins. Conversely, a stable or declining COGS relative to sales suggests that a company is managing its supply chain effectively or benefiting from economies of scale. However, investors should be aware that different inventory accounting methods (such as FIFO or LIFO) can alter how COGS is reported, making it important to compare companies using the same accounting standards.

A bicycle manufacturer generates $1,000,000 in revenue by selling 1,000 bicycles. To produce these bicycles, the company spent $300,000 on raw materials (metal, rubber, gears), $150,000 on factory worker wages, and $50,000 on factory electricity and rent. The direct costs are summed to find COGS: $300,000 + $150,000 + $50,000 = $500,000. This leaves the company with a gross profit of $500,000 ($1,000,000 revenue - $500,000 COGS).