What is COGS?
COGS (Cost of Goods Sold) · Also called cost of goods sold, cost of goods, cost of sales, unit cost, product cost
COGS, or cost of goods sold, is the inventory cost you recognize when products sell. Making or buying inventory does not make it COGS until the units are sold.
What it is
For a CPG brand, product cost usually includes ingredients, primary and secondary packaging, the co-packer's conversion charge, inbound freight, production quality costs, and normal yield loss. Eligible freight and prep to get finished goods to your warehouse can be included too, which makes it a landed cost.
That cost sits on your balance sheet as inventory until the units sell. Then it moves to COGS. Cash you pay a supplier this month is not necessarily this month's COGS.
Normal production loss belongs in unit cost. Abnormal waste, such as a failed batch, is usually recorded as a separate expense rather than spread over the good units. Selling and general costs such as trade spend, broker commissions, marketing and office rent sit below gross profit.
Why it matters
COGS sets the ceiling on everything else. What is left after it has to pay for trade spend, marketing and the team.
Getting the line between inventory and COGS right keeps your gross margin honest month to month. A big production run in one month should raise inventory, not that month's COGS.
Formula
Unit cost = Ingredients + Packaging + Conversion + Inbound freight + Quality costs and normal yield loss + Freight and prep to your warehouse
Over a period, for finished goods: COGS = Beginning inventory + Cost of units added − Ending inventory, with separate adjustments for write-downs and abnormal losses.
Worked example
Building up a $1.35 unit cost
- Assume a normal production run. Per sellable unit: ingredients $0.50, primary packaging $0.32 and secondary packaging $0.12, which add up to $0.94.
- Add the co-packer's conversion charge of $0.12, inbound freight of $0.07, and quality costs and normal yield loss of $0.07: $0.94 + $0.26 = $1.20 per unit from the co-packer.
- Add $0.15 per unit of freight and prep to reach your warehouse: $1.20 + $0.15 = $1.35 inventory cost per unit.
- You receive 10,000 units, so $13,500 goes into inventory. If 8,000 sell this month, their COGS is 8,000 × $1.35 = $10,800. The other 2,000 units stay on the books as $2,700 of inventory.
- At $2.70 net revenue per unit, gross profit is $2.70 − $1.35 = $1.35, a 50% gross margin.
Common mistakes
- Treating everything you paid a supplier this month as this month's COGS, instead of recognizing cost as units sell.
- Using a turnkey co-packer quote as one line and then adding the same materials again, or using a tolling fee as your whole cost and leaving materials out.
- Spreading a failed batch or other abnormal waste over the good units, which hides the loss in your margin.
- Using a percentage of SRP in place of a bill of materials and a current production quote.
Common questions
- Are all salaries and rent excluded from COGS?
- No. Production labor and manufacturing overhead that can be allocated to production can be product costs. Sales-team payroll and general office rent usually are not. Decide by what the cost is for, not by its name.