Cost of Goods Sold (COGS) represents the direct costs attributable to the goods sold by a company during a specific period.
What COGS Includes
Physical goods businesses: - Raw materials - Packaging - Direct labor (workers directly producing the goods) - Manufacturing overhead (depreciation of production equipment, factory utilities) - Inbound freight
SaaS and software (called Cost of Revenue): - Cloud hosting and infrastructure - Support team directly serving customers - Third-party API costs per transaction - Implementation and onboarding costs
COGS on the Income Statement
COGS sits directly below revenue:
Revenue $1,500,000
- COGS ($870,000)
= Gross Profit $630,000 (42% margin)
- Operating Expenses ...
= Operating Income ...
Why COGS Accuracy Matters
Misclassifying operating expenses (like sales salaries) as COGS inflates gross margin and understates operating leverage. Investors and acquirers look closely at COGS composition, especially in SaaS — overstated gross margin is a common red flag in M&A diligence.