Profitability
Cost of Goods Sold
The direct costs of producing or delivering what you sold — the expense matched against revenue to get gross profit.
Cost of goods sold (COGS) captures the costs directly tied to delivering your product or service: raw materials, manufacturing labor, hosting costs for software, payment processing fees, shipping. If the cost would exist only because you made that sale, it probably belongs in COGS. Everything else — sales salaries, rent, tools — is operating expense below the gross profit line.
Where a cost sits matters enormously. COGS determines gross margin, the single number investors use to compare unit economics across companies and track whether your business gets more efficient as it scales. Moving costs that don't belong there inflates margin and misleads everyone reading the P&L; burying real delivery costs in OpEx deflates it and hides the true cost of serving customers.
Example
A hardware startup sells a device for $199. Components cost $60, assembly labor $15, and shipping $8 — COGS is $83, gross profit is $116, gross margin is 58%. Rent, the engineering team's salaries, and ad spend are operating expenses and don't touch the gross margin calculation.
Common questions
What costs should not be in COGS?
Costs that aren't directly tied to producing or delivering what was sold: rent, salaries of non-production staff, sales and marketing, software subscriptions for internal tools, and general administrative costs. Those are operating expenses (OpEx) below the gross profit line.
Is COGS cash or accrual?
Accrual. COGS records the cost of what you sold in the period the revenue is recognized — regardless of when you paid the supplier. A payment for inventory sitting in a warehouse isn't COGS yet; it becomes COGS only when the related item is sold.
Practice this in the game
Accrual World turns concepts like these into playable drills. Pick the account, pick debit or credit, and get instant feedback. Free, no signup.
Play now