COGS is the direct cost of producing the goods a business sells.
Short for cost of goods sold, COGS also covers the purchase cost of products a retailer resells. It matches those costs to the goods sold during a reporting period. Goods still on the shelf belong in inventory until sold, rather than being charged immediately against revenue.
This guide explains the formula, common classifications and an illustrative Canadian example. For other financial terms used in a business plan, visit the Business Finance Glossary.
The COGS formula
COGS = Beginning Inventory + Purchases (and direct production costs) − Ending Inventory
Beginning inventory is the cost of goods held at the start of the period. Purchases add goods acquired during that period; a producer also includes applicable production costs. Ending inventory is the cost of goods still held at the end. Use cost values throughout, not selling prices.
For a retailer, purchases normally mean merchandise bought for resale, adjusted for supplier returns and discounts. A producer tracks materials, work in progress and finished goods. Add production costs only once: if they are already included in the inventory or purchases figures, do not add them again.
Use the same period for revenue and COGS. A monthly calculation needs opening and closing inventory for that month. Count stock consistently and document how you value it. Paying a supplier this month does not automatically make the whole payment this month's COGS.
Check the stock records against the physical count before relying on the result. Missing goods, spoilage and supplier credits can affect the figures. Record any necessary adjustments under your accounting policy, and keep the calculation traceable to purchase invoices and inventory records. That makes it easier to explain differences between a forecast and actual results.
What counts as COGS?
For a small product business, common direct costs include:
- Raw materials: ingredients, timber or components used to make products sold.
- Direct labour: wages for the time employees spend making those products.
- Product packaging: jars, bottles or boxes that form part of the finished product.
- Goods bought for resale: the retailer's purchase cost of merchandise sold.
Common operating expenses excluded from this simplified direct-cost list include:
- Rent: shop or office occupancy costs.
- Marketing: advertising, promotions and sales campaigns.
- Administrative salaries: bookkeeping and general management staff.
- Delivery to customers: outbound shipping and distribution expenses.
The line matters because revenue minus COGS equals gross profit; moving a cost between COGS and operating expenses changes reported gross margin.
Classification needs context. Manufacturing inventory may also include allocated production overhead, such as factory rent, under the applicable accounting framework. Freight to bring stock into saleable condition differs from outbound customer delivery. A fulfilment business may present delivery within cost of revenue. Document your policy and confirm the treatment with your accountant.
Illustrative example: a Canadian retailer
Illustrative example: Maple Pantry is a fictional small Canadian retailer selling packaged food. These round numbers are invented to demonstrate the calculation for one month, in Canadian dollars. They are not industry averages or performance targets. This retailer buys finished goods and has no separate production costs.
| Item | Amount |
|---|---|
| Beginning inventory at cost | $10,000 |
| Purchases for resale | $25,000 |
| Ending inventory at cost | $15,000 |
| Sales revenue | $40,000 |
First, calculate the goods available for sale: $10,000 + $25,000 = $35,000. Subtract the $15,000 of goods remaining in stock:
COGS = $10,000 + $25,000 − $15,000 = $20,000
Next, carry that result into gross profit:
Gross Profit = Revenue − COGS
$40,000 − $20,000 = $20,000
Then express gross profit as a percentage of revenue:
Gross Margin = Gross Profit ÷ Revenue × 100
$20,000 ÷ $40,000 × 100 = 50%
In this example, each sales dollar leaves 50 cents before operating expenses, financing costs and income taxes. Gross profit is not net profit or available cash. The retailer must still cover rent, marketing, administration and customer delivery. Cash also depends on when customers pay and supplier bills fall due.
COGS vs operating expenses vs cost of revenue
| Term | Meaning | Examples |
|---|---|---|
| COGS | Cost assigned to the goods sold during the period. | Merchandise, materials and direct production labour. |
| Operating expenses | Costs of running the business outside cost of sales. | Office rent, marketing and administrative salaries. |
| Cost of revenue | A broader label for costs of delivering revenue, depending on the business and its accounting policy. | Product costs, service delivery staff or hosting used to provide a digital service. |
For services businesses, “COGS” is often called cost of services: direct delivery costs such as billable staff time or subcontractors, even when there is no physical inventory.
Read the line-item definitions before comparing businesses. Gross margin and EBITDA measure different levels of earnings; our EBITDA meaning guide explains what gets added back after calculating net income.
Gross margin also differs from markup. Margin divides gross profit by revenue; markup divides it by product cost. In the retailer example, the 50% margin corresponds to a 100% markup on the $20,000 cost. Naming the denominator avoids confusing the two percentages.
Why COGS matters in a business plan
Lenders read gross margin as a viability signal: does pricing leave enough after product costs to support the rest of the business? It is one part of the assessment, alongside operating expenses, cash flow and repayment obligations. A positive gross margin alone does not establish that borrowing is affordable.
In the financial projections section, connect forecast sales volumes and prices to unit costs. Explain supplier pricing, labour requirements, packaging and inventory assumptions. Show why the margin changes over time, rather than assuming that sales growth automatically improves it. Include a downside case for higher input costs or lower selling prices.
Carry inventory assumptions into the projected balance sheet and supplier payments into the cash-flow forecast. Buying more stock can use cash before sales occur. For help presenting these connected statements, see our business plan writing services.
Frequently asked questions
Is labour part of COGS?
Direct labour used to produce goods is generally included in their cost. Administrative salaries and sales staff normally belong in operating expenses. For staff with mixed duties, use a supportable allocation of time and apply it consistently.
Is COGS the same as expenses?
No. COGS is one category of expense, covering goods sold. Total expenses also include operating costs, interest and other applicable charges. Unsold stock generally remains inventory until sold, subject to any required write-down.
How do I calculate COGS with no inventory?
If both beginning and ending inventory are zero, the formula reduces to purchases and applicable production costs for goods sold. A service business instead totals direct service delivery costs for the period, often labelled cost of services. Do not classify every business expense as COGS.
What gross margin is “good”?
It varies by industry, product mix, pricing model and cost classification. There is no universal benchmark. Compare consistently defined figures from relevant sources and explain whether your projected gross profit covers operating expenses and supports the business's financing needs.