Cost of Sales vs. COGS Explained

Defining Cost of Sales and (COGS)

Cost of Sales

Cost of sales is the total cost of producing and selling goods or services. It includes things like materials, labor, and overhead costs directly tied to production. For a manufacturing company, cost of sales typically makes up a large portion of total expenses. To calculate it, you take the cost of beginning inventory plus purchases less ending inventory.

COGS (Cost of Goods Sold)

COGS, on the other hand, refers specifically to the cost of materials and labor directly used to manufacture products. It excludes operating expenses like rent, utilities, and administrative salaries.

COGS is usually a subset of total cost of sales. For a retailer, COGS includes the amount paid to suppliers for inventory sold during an accounting period.

For businesses, monitoring cost of sales and COGS is important for controlling expenses and maintaining profitability. While COGS is the key data point when calculating your gross profit, cost of sales gives you an overview of total costs related to the overall production of your goods.  Both metrics should be reviewed regularly and analyzed for trends to optimize pricing, improve efficiency, and boost the bottom line.

Keeping cost of sales and COGS under control is key to running a successful business. Understanding the difference between these two concepts will help you gain valuable insight into your company's financial performance and set the right course for increased profits.

The Key Differences Between Cost of Sales and COGS

Cost of sales and cost of goods sold (COGS) are two terms that often get used interchangeably in accounting, but there are a few key differences you should understand.

Cost of Sales

Cost of sales refers to the costs related to producings the goods or services sold by a company. This includes things like raw materials, packaging, labor, and overhead. For a retailer, cost of sales would include the cost to purchase inventory that is then sold to customers. Essentially, cost of sales includes all the expenses directly tied to generating revenue.

COGS

COGS, on the other hand, only includes the costs directly attributable to producing or purchasing the goods sold. This typically means the cost of raw materials and direct labor. For a manufacturer, COGS would include the cost of components and the wages of factory workers. For a retailer, COGS is simply the cost to purchase inventory.   For an e-commerce brand or dropshipper, COGS is typically the full cost of the finished item you're selling including cost to purchase the product or materials, freight, and duties.  Overhead expenses like rent, utilities, and administrative salaries are not included in COGS.

Why The Difference Matters

The difference between cost of sales and COGS comes down to which costs are directly tied to generating revenue. COGS is a more narrow measure that only includes the bare essentials. Cost of sales casts a wider net and incorporates more indirect costs.

As an analyst, investor or company operator, you need to understand which measure a company is using in their financial statements. COGS will result in a higher gross margin, while cost of sales will result in a lower gross margin. Both can provide useful insight, you just need to make sure you're comparing apples to apples!

An Example of Cost of Sales vs. COGS - Bakery

Let's look at this example to illustrate the difference between Cost of Sales and (COGS).

Imagine you own bakery that sells cakes. The bakery's costs can be broken down as follows:

In this example:

Cost of Goods Sold (COGS) includes only the direct costs associated with producing the cakes:

Cost of Sales, on the other hand, includes COGS and other indirect costs that are necessary for making sales:

The key difference is that COGS focuses solely on the direct costs of production, while Cost of Sales encompasses a broader range of expenses, including overhead costs that are essential for the business to operate and generate sales.

Example 2 - Cost of Sales vs. COGS - Dropshipper

Now let's look at a slightly different example - a dropshipping business (a businesses that buys finished goods from a supplier and the resells them).  In this case, the elements of COGS and cost of sales are slightly different.

In this scenario, the dropshipper sells phone cases online without holding any inventory.  Here are the general company costs:

COGS includes only the direct costs associated with acquiring the phone cases:

Cost of sales includes COGS but also the indirect costs included in getting the phone case to the end customer:

How Cost of Sales and COGS Relate to Inventory

Both cost of sales and COGS are closely connected to a company’s inventory, since inventory represents goods that have been purchased but not yet sold. As inventory is sold, its costs are transferred to COS and COGS. The costs of any unsold goods at the end of an accounting period remain in inventory as an asset on the balance sheet.

To calculate COS and COGS, companies use one of three inventory costing methods: first-in, first-out (FIFO); last-in, first-out (LIFO); or weighted average. The method a company chooses can significantly impact its income and balance sheets. FIFO assumes older inventory costs are transferred to COS/COGS first. LIFO assumes most recent costs are transferred first. Weighted average allocates total inventory costs proportionally to units sold.

When to Use Cost of Sales vs. COGS for Financial Reporting

When to use COGS

Use COGS when you're reporting your gross profit on your income statement. Gross profit is your revenue minus COGS, and it shows how profitable your products are without considering indirect expenses. This is important for understanding your production efficiency and pricing strategies.

When to use Cost of Sales

However, when you're presenting your overall profitability, you'll want to use Cost of Sales. This is typically found on your income statement as well, but further down, as part of your operating expenses. By including Cost of Sales here, you're giving a more complete picture of your business's profitability after considering all the costs involved in making those sales happen.

Another thing to keep in mind is consistency. Once you choose whether to use COGS or Cost of Sales for a particular financial report, stick with it. Consistency helps you compare your financial performance over time and makes it easier for investors or lenders to understand your business.

So, when you're putting together your financial reports, think about the story you want to tell. Use COGS to highlight your production efficiency and gross profitability, and use Cost of Sales to show your overall business performance. And remember, consistency is key!

Conclusion

So there you have it - the nitty gritty on cost of sales vs. COGS. At the end of the day, while they sound similar, these terms refer to different calculations that serve different purposes. Cost of sales gives you the total costs directly tied to generating revenue for a period, while COGS focuses only on the expenses related to purchasing or making what you sell during that time frame. Hopefully breaking down these definitions helps you better understand the costs flowing through your income statement. Keep this knowledge in your back pocket as you analyze financial statements and make business decisions going forward. The differences between these terms might seem subtle, but understanding them can have a big impact on how you run your business!

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