Cost of goods sold (COGS) is the total of all costs used to create a product or service, which has been sold. These costs fall into the general sub-categories of direct labor, materials and overheads. In a service business, the cost of goods sold is considered to be the employee costs and other direct expenses.
COGS = Inventory at the beginning of the period
+ Purchases during the period
- Inventory at the end of the period
Because cost of goods sold is a cost of doing business (manufacturing the goods or providing the service), it is recorded as a business expense on the income statement. Knowing the cost of goods sold helps analysts and investors estimate the company’s bottom line. If COGS increases, net income will decrease. Therefore, aim of any business is to keep COGS low, so that net profits will be higher.