Cost of sales (also known as cost of goods sold (COGS)) refers to the direct costs a business incurs to produce or purchase the goods or services it sells. It includes all expenses directly linked to delivering a product or service to customers.
In simple terms, cost of sales is what it costs you to make or buy what you sell.
How Cost of Sales Works
When a business sells a product or service, it must account for the direct costs involved in that sale. These costs are recorded as cost of sales and are deducted from revenue to calculate gross profit.
For example, if a café sells a coffee for $5 and the ingredients cost $1.50, the $1.50 is the cost of sales. The remaining $3.50 contributes toward covering other expenses and profit.
What Is Included in Cost of Sales
Cost of sales typically includes:
- Raw materials or ingredients
Such as food supplies, components, or stock - Direct labour
Wages for staff directly involved in production or service delivery - Purchase cost of goods
For retailers, this is the cost of buying products to resell - Freight or delivery costs (in some cases)
If directly tied to bringing goods in for sale
Only costs directly related to producing or delivering goods or services are included.
What Is Not Included
Cost of sales does not include indirect or operating expenses such as:
- Rent
- Marketing and advertising
- Administrative salaries
- Utilities not directly tied to production
These are treated separately as operating expenses.
Cost of Sales Formula
Cost of sales is often calculated using this formula:
Opening Inventory + Purchases − Closing Inventory = Cost of Sales
This helps businesses understand how much stock was actually used or sold during a period.
Why Cost of Sales Matters
Cost of sales is important because it:
- Determines gross profit
- Helps with pricing decisions
- Shows how efficiently a business is producing or sourcing products
- Impacts overall profitability
If cost of sales is too high, even strong sales revenue may not result in good profits.
Cost of Sales in Different Businesses
- Retail businesses
Mainly include the purchase cost of goods - Restaurants and cafés
Include ingredients, food supplies, and kitchen-related costs - Service businesses
May include labour directly linked to delivering the service
Each industry calculates cost of sales slightly differently depending on how products or services are delivered.
Risks and Considerations
- Rising supplier costs can increase cost of sales
- Waste or spoilage reduces efficiency
- Poor inventory management can distort figures
- Incorrect pricing may not cover actual costs
Regular monitoring is essential to maintain healthy profit margins.
How to Manage Cost of Sales
- Track inventory accurately
- Negotiate better supplier pricing
- Reduce waste and improve efficiency
- Review portion sizes or usage in hospitality
- Use POS or accounting systems to monitor margins
- Adjust pricing when costs change
Where It Appears
Cost of sales appears on the income statement (profit and loss statement). It is deducted from revenue to calculate gross profit, which is a key measure of business performance.
Summary
Cost of sales represents the direct cost of producing or purchasing what a business sells. It is a critical figure for understanding profitability, setting prices, and managing operations. Keeping cost of sales under control helps ensure a business remains sustainable and financially healthy.