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Learn to identify which expenses are actually a cost of sales

Quick reference

Cost of Goods Sold

Cost of Goods Sold (COGS) is the total cost directly involved in producing goods or services that a business sells. The types of COGS can vary depending on the type of business.

Examples:

  • Software resold by a bookkeeper
  • Ingredients for a coffee shop
  • Outsourced services for a photographer
  • Books for sale when a speaker is at an event 

Gross Profit is the difference between sales and COGS. It represents the funds available to cover operating expenses and profits.

Note: not all businesses will have COGS, particularly if they do not sell physical goods.

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  • 00:05 Cost of goods sold is the direct cost of the products or
  • 00:09 services a business sold to the customer or client.
  • 00:13 This is going to be the purchase of products, the purchase of labor,
  • 00:18 and the raw materials used to create the products.
  • 00:21 Let me give you some examples.
  • 00:24 In the case of bookkeeping, if a bookkeeper purchases software to
  • 00:29 resell to the client, that's the cost of goods.
  • 00:32 When the coffee shop purchases beans and syrups and milks and
  • 00:36 all those other good things, those are cost of goods.
  • 00:40 The photographer, they're outsourcing the photo editing
  • 00:44 to provide the best quality photos, that's the cost of labor.
  • 00:49 An event speaker who sells their books at the event, that's the cost of goods.
  • 00:55 Gross profit goes hand in hand with cost of goods sold.
  • 00:58 Gross profit is calculated as the difference between the income and
  • 01:03 the cost of goods sold.
  • 01:05 Knowing how much money a company is actually making after buying the goods and
  • 01:09 services that they sell, that's extremely informative.
  • 01:13 One of my mentors, Cashflow Mike, describes it really well.
  • 01:17 He says, it is the only place you can go to get cash to put into your pocket or
  • 01:22 pay your bills.
  • 01:24 I think reviewing cost of goods sold in gross profit is best
  • 01:28 illustrated by seeing it in action.
  • 01:31 What you see on my screen is the sample QuickBooks online file.
  • 01:35 You see a profit and loss for January through November.
  • 01:39 This business had an income of $5,000,
  • 01:42 the cost of goods sold is 200, and the gross profit is 4,800.
  • 01:48 What this report is telling us is that in order for the business to collect or
  • 01:53 earn the $5,000, they had to spend $200.
  • 01:58 Their gross profit is $4,800.
  • 02:01 The $4,800 is the money that the business has available
  • 02:06 to pay its operating expenses.
  • 02:08 If the business collected $5,000, but
  • 02:12 spent $6,000 in order to collect it, that would be a problem.
  • 02:18 It's important for a business to know not only how much money did they collect,
  • 02:23 but how much money did they spend in order to earn and collect that money.
  • 02:28 That's the gross profit.
  • 02:30 In the example of Xero, the sales are 29,000,
  • 02:34 the cost of goods is 2,300, the gross profit is 26,000.
  • 02:40 In the FreshBooks sample file, the cost of goods sold is 0.
  • 02:44 This make-believe company did not have any cost of goods sold.
  • 02:48 What that means is that the gross profit is equal to the income,
  • 02:53 and the gross profit margin is 100%.
  • 02:56 Not every business is going to have a cost of goods sold.

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