What does 'cost of goods sold' (COGS) refer to?

The term 'cost of goods sold' (COGS) specifically refers to the direct costs associated with the production of goods that a company sells during a specific period. This includes expenses directly tied to the manufacturing of the product, such as materials and labor used in the production process. Understanding COGS is essential because it directly affects the gross profit of a company; lower COGS leads to higher gross profit margins.

For a company, accurately calculating COGS is crucial for financial reporting and tax purposes, as it directly influences the calculation of profitability. The process involves inventory management, which tracks both the cost of materials and direct labor incurred in creating a product.

In contrast, general business expenses, marketing expenses, or research and development costs do not fall under COGS since they are not directly related to the manufacturing of goods sold. These expenses are accounted for separately on financial statements and have different implications for a company's operational analysis and financial health.