How to Calculate Cost of Goods Sold (COGS) for Small Businesses

Running a small business means keeping a close eye on your expenses - especially those directly tied to your product or service. One of the most important numbers to understand is Cost of Goods Sold (COGS).

COGS helps you determine how much it actually costs to produce what you sell, giving you a clearer picture of your profit margins.

What Is Cost of Goods Sold (COGS)?

COGS includes all the direct costs involved in producing or purchasing the goods your business sells during a specific period.

For example:

• A bakery’s flour, sugar, and baking labor are COGS.

• A retail store’s inventory purchase costs are COGS.

❗️COGS does not include rent, marketing, or administrative salaries. Those are considered indirect expenses.

Why COGS Matters

Understanding your COGS is crucial because it affects:

• Profitability: It helps you calculate gross profit (Revenue – COGS).

• Pricing Strategy: You can’t price products properly without knowing your true costs.

• Taxes: COGS is a deductible expense on your tax return.

• Inventory Control: It highlights overstocking, theft, or poor tracking.

The Basic COGS Formula

Use this simple formula:

COGS = Beginning Inventory + Purchases – Ending Inventory

Let’s define each part:

• Beginning Inventory: The value of what you had on hand at the start of the period.

• Purchases: New inventory or materials bought during the period.

• Ending Inventory: The value of what’s still on hand at the end of the period.

Example: A Clothing Retail Shop

Let’s say you run a boutique that sells clothes:

• Beginning Inventory (Jan 1): $2,000

• Purchases (Jan–Mar): $5,000

• Ending Inventory (Mar 31): $1,500

COGS = $2,000 + $5,000 – $1,500 = $5,500

This means it cost you $5,500 to purchase the goods you sold in that quarter.

What to Include in COGS

Depending on your business, COGS might include:

For product-based businesses:

• Raw materials

• Direct labor (workers making the product)

• Packaging costs

• Shipping or freight for supplies

• Wholesale costs of items for resale

For service-based businesses:

• Billable labor

• Materials used in delivering the service

• Subcontractor fees

Tips for Tracking COGS Accurately

• Use accounting software (such as Xero and Quickbooks) for inventory and expense tracking.

• Conduct regular inventory counts to ensure accuracy.

• Separate your direct and indirect expenses carefully.

• Save all receipts and invoices for purchases.

Final Thoughts

COGS is one of the most important figures in your financial toolkit. It reveals whether you’re making or losing money every time you make a sale.

By tracking your COGS regularly, you’ll have better control over pricing, inventory, and profits.

Need Help?

If you’re not sure where to start, working with a bookkeeper like us (Transfigures Bookkeeping) can help you:

• Set up your inventory tracking

• Categorize your expenses correctly

• Maximize your tax deductions

Book an appointment with us to get started.

📌 Tip: Bookmark this post and review your COGS monthly or quarterly to stay on top of your financial health.