What is COGS?

Knowing what an item costs helps you price it. Reporting cost of goods sold is a separate accounting task: the method, the type of cost and the business structure matter. Keep the inputs separate so one useful pricing total does not become an unsupported tax figure.

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The formula

A common inventory calculation is beginning inventory plus purchases and other includible costs, less ending inventory. Manufacturing and other accounting methods can require additional adjustments. It is not simply the cash spent on ingredients this month.

IRS Publication 334 explains U.S. small-business inventory and COGS treatment. Packaging treatment depends on its function; not every box or mailer is an inventory cost. A sole proprietor cannot deduct the value of their own labor.

Keep the cost categories separate

  • Record purchased goods and materials with invoices, quantities and dates.
  • Keep paid production labor and other production costs identifiable.
  • Record packaging, outbound shipping and selling fees separately for classification.
  • Keep inventory records and ask your preparer which method applies to your business.

Choosing a convenient category does not make it appropriate for a return. Ask how each cost is treated, and avoid including it in both COGS and another expense line.

Gross profit and gross margin

Gross profit is revenue less COGS; gross margin is gross profit divided by revenue. A $40 sale with $18 in COGS has $22 gross profit and a 55% gross margin. This is before selling expenses and other overhead, and it is not necessarily cash available to spend.

How to calculate per-unit COGS for a handmade product

Start with quantities and purchase costs for the materials used, then identify the other production costs assigned under your accounting method. Divide an appropriate batch cost by its saleable yield. Track waste and unsold inventory rather than assuming every unit produced was sold.

For pricing, you can separately estimate the value of your own time, packaging, selling fees and overhead. Label the result a pricing-cost estimate. For example, $8 of materials plus $12 of estimated owner time gives a $20 planning subtotal, not automatically $20 of deductible COGS.

Common mistakes

  • Using the same total for pricing, gross margin and taxable profit without checking what it contains.
  • Counting supplies, shipping or labor twice.
  • Ignoring waste, inventory on hand or changes in purchase costs.
  • Confusing markup (profit divided by cost) with margin (profit divided by revenue).

COGS is the input to profit margin and the focus of recipe costing for food sellers specifically. See the templates for home bakers, templates for craft sellers, and templates for Etsy sellers hubs for the full small-business toolset.

Templates that implement this

7 templates

Ingredient costing, recipe pricing, packaging math, labor allocation — built for the small businesses that actually need to get this number right.

Further reading

Cost of goods sold in practice — costing recipes, pricing handmade work, and finding real margin.