Cost of Goods Sold: Cost of Goods (COGS) or Costs of Sales (COS) appear on the Income Statement and represent the cost to the organization of creating its product or service. This typically includes material labor to produce the product or direct costs (expenses) to deliver a service. COGS is a major metric in the determining profitability.
If a company’s product or service direct costs are close to that of the net price to the customer, there is a likelihood that the company will be losing money. Note: This account can be confusing for many service companies. If a service company has any direct cost associated with its service, those direct cost need to be reflected in this account. An example would be a consulting company where the COGS would include labor, transportation, and room and lodging to a client’s location. But, costs incurred to attain clients would be considered marketing and would not be entered here. If a company leaves out the labor element of COGS it can lead to pricing a service too low or even below costs causing the company’s net profits (income) to be a loss.
Often companies that provide a service rather than a product will not record any COGS or COS in their financial records. This results in 100% Gross Margin and it is difficult for these companies to set service pricing to insure profitability. Another common oversight in a service business is not considering labor in COS to provide the service. In a service business labor is usually the highest cost in their Cost of Sales, so not including these labor costs can lead to low pricing causing net profits to be very low. Both hourly and salaried personnel that provide services should allocate their time when they are directly providing a service to a customer. This time and cost would be included in COS and their remaining costs would be considered overhead.
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