Cost of Sales Definition: What Is Cost of Sales?

The cost of sales refers to all the direct and indirect costs it takes to create a product and sell it on the market. This can include the cost of labor, cost of raw materials, cost of storage, and other overhead expenses.

In general, cost of sales and cost of goods sold (or COGS) refer to the same thing, although the former might refer specifically to the sale of services whereas the latter might relate more directly to manufacturing products.

Calculating COGS (cost of goods sold) and cost of sales is simple. As a basic template, add the cost of raw materials, labor, operating costs, and any other overhead costs it takes to bring inventory items or services to market.

After adding all these elements together, you have your cost of sales and can compare it against revenue, profits, and the like. You can also find your cost of sales by adding your beginning inventory to the amount of revenue you bring in via customer purchases and then subtracting your ending inventory.

Taking stock of how much it takes to sell your products and services is important for various reasons. Your cost of sales figure is important because it:

• Offers insight into your business: When you know your cost of sales, you get a more in-depth look at your business’ bottom line. By comparing this metric against others, you can see if the sales revenue you take in surpasses the cost to do those sales in the first place. A positive income statement in relation to your cost of sales is a sign your business is on the right track.
• Provides valuable information to investors: Cost of sales is one of several line items investors hope to see when pondering whether or not to put money into your company. The more thorough your financial statements are on this front, the better. Alongside profits, revenue, and other key metrics, cost of sales helps determine the overall valuation of your company.
• Tracks your gross profit margins: Comparing expenditures against gross and net profits helps you determine the overall success of your business. If your cash flow exceeds the amount of money you spend on selling goods, your gross margins are healthy. If the cost of revenue and sales comes in higher than your profit margins, it’s a sign you’re losing money.

Different businesses will look at cost of sales from different angles. Consider these three examples:

1. 1. A law firm: While some companies offer tangible products, law firms provide intangible and intellectual services to their clients. As a result, the cost of sales for an entity like this would more likely include administrative expenses and labor costs than anything related to manufacturing. These variable costs might fluctuate depending on a host of factors, like the type of case, experience of the attorney, and more.
2. 2. A restaurant: To sell food, restaurants must pay a lot of direct costs up front. These include both variable and fixed costs for labor, ingredients, and upkeep. Restaurants then pass these costs on to customers with a markup so they can bring in profits and build net income.
3. 3. A toy company: Suppose a company sells toys to retailers. To sell these goods, the company must pay both direct material and direct labor costs to keep their production process moving smoothly. They also must cover any expenses involved in shipping their products to retailers (unless they pass these costs on to the retailers themselves). All these tally up to the total cost of sales.

After you total up your cost of sales, you can put it to use by using several different accounting methods. These are three of the most common:

1. 1. Average cost method: Choose a period of time like a financial quarter or an entire year, then add up what it cost you to sell goods for that entire amount of time. For instance, by averaging out the costs on an annual scale, you’ll have a fairly accurate total of your overall cost of sales by the end of the year.
2. 2. FIFO method: The “First In, First Out” (or FIFO) method entails selling the first goods added to your inventory before anything else. Over an accounting period, this generally leads to a lower cost of sales total than you might see if you were to use the last in, first out method instead.
3. 3. LIFO method: Some companies spurn the FIFO approach to record things in reverse. In the “Last In, First Out” (or LIFO) method, you sell the latest goods you added to your inventory account first. These generally have a higher value, so you can expect the cost of sales to decrease on your balance sheet over time if you use this method. Still, it will likely also yield you a higher number overall.

The cost of sales formula is the same as the cost of goods sold formula (or COGS formula)—the only thing that might change is the potential inputs. Some companies prefer to use the term “cost of sales” when they specifically offer services rather than tangible products. The reverse is also true when it comes to companies offering tangible products and the term “cost of goods sold.”

MasterClass at Work is the learning platform to help unlock the full potential of your employees and inspire a learning lifestyle in everyone. From negotiation to mindfulness to baking—these are just a few things your teams can explore.