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Cost of Sales, also known as Cost of Goods Sold (COGS), is a term used in accounting and finance to represent the direct costs attributable to the production of goods sold by a business. This includes the cost of the materials used in creating the goods (raw materials, direct labor costs used to produce the good, direct factory costs related to the production of the good) along with any direct costs linked to the sale of these goods.
For example, if a company manufactures furniture, the cost of sales might include the wood, screws, paint, labor for carpenters, and factory overhead. If a retailer sells furniture, the cost of sales will be what they paid to buy the furniture from the manufacturer.
Remember, the cost of sales only includes the direct costs to produce the goods or services that a company sells, not indirect costs such as distribution costs and sales force costs.
Cost of Sales and Operating Expenses are both expenses incurred by a business, but they are categorized differently on a company's income statement.
The key difference between the two is that cost of sales relates to the direct costs of producing the goods or services a company sells, while operating expenses relate to the costs of running the business itself.
To calculate the cost of sales, you need to add the value of inventory at the beginning of the period to any purchases made during that period, and then subtract the value of inventory at the end of the period. It can be represented by the following formula:
Cost of Sales = Opening Inventory + Purchases - Closing Inventory
Let's break it down:
Understanding the cost of sales is important for several reasons:
In simple terms, the cost of sales is the cost incurred to produce the products or services sold by a company. It includes direct costs like raw materials and labor costs, but not indirect costs like distribution or marketing costs. The cost of sales is important because it directly affects a company's profitability, helps in pricing products, aids in inventory management, and plays a crucial role in financial analysis.