Your cost of goods sold (COGS) is the costs directly related
to purchasing products for resale, manufacturing products to sell, or providing
services. Your COGS is documented on your income statement and used to
calculate your gross profit margin. You can deduct your COGS from your
company’s income as a business expense, which will reduce your tax liability.
What are direct costs?
The direct costs of your goods will vary from business to
business, but they can include:
Add your beginning inventory to any purchases made during
the period. Then, subtract your ending supply.
If you begin the period with $5,000 in
inventory, purchase $2,000 in materials during the period, and end the period
with $3,000 in stock, your COGS is $4,000.
What if your costs change during the year?
If your direct costs change during the
year, there are three methods for calculating COGS:
in, first out (FIFO)
in, first out (LIFO)
Let’s pretend you bought products for resale in three
batches during the year and sold 400 units.
Batch 1: 100 units at $10 each ($1,000 total)
Batch 2: 250 units at $10.50 each ($2,625 total)
Bach 3: 150 units at $11 each ($1,650 total)
Using the FIFO method, assume that the first products
purchased were the first products sold. That means you sold 100 products at $10
each, 250 products at $10.50 each, and 50 products at $11 each. Your COGS would
Using the LIFO method, assume that the last products
purchased were the first products sold. So, you sold 150 products at $11 each
and 250 products at $10.50 each. Your COGS is $4,275.