COGS stands for Cost of Goods Sold, which is the total cost a business has paid out of pocket to sell a product or service. It is an accounting term that refers to the direct costs of producing the goods sold by a company. COGS includes any direct costs that a business incurs in the manufacture, purchase, and sale or resale of products. It is an important metric on financial statements as it is subtracted from a company’s revenues to determine its gross profit. Gross profit is a profitability measure that evaluates how efficient a company is in managing its labor and supplies in the production process.

Expenses that are included in COGS cannot be deducted again as a business expense. COGS expenses include the cost of products or raw materials, including freight or shipping charges, the direct labor costs of workers who produce the products, and the cost of storing products the business sells. COGS is used by companies that make products, including those in the manufacturing, technology, aerospace, transportation, telecommunications, agricultural and food, and construction sectors.

Knowing the cost of goods sold helps analysts, investors, and managers estimate a company’s bottom line. If COGS increases, net income will decrease, and the business will have less profit for its shareholders. Businesses thus try to keep their COGS low so that net profits will be higher. COGS can easily be manipulated by accountants or managers looking to cook the books. It can be altered by allocating to inventory higher manufacturing overhead costs than those incurred, overstating discounts, overstating returns to suppliers, or altering the amount.