COGS stands for Cost of Goods Sold, which refers to the direct costs of producing the goods sold by a company. It is an important metric on financial statements as it is subtracted from a company’s revenues to determine its gross profit. COGS includes costs such as raw materials and labor that vary depending on the amount of product produced, but it does not include indirect costs that the business incurs regardless of how much is produced, such as office expenses, administrative salaries, or marketing costs.

Knowing the cost of goods sold helps analysts, investors, and managers estimate a company’s bottom line. If COGS increases, net income will decrease, which is beneficial for income tax purposes, but the business will have less profit for its shareholders. COGS is a key component of determining two critical business metrics: a company’s gross profit and its gross margin. COGS is only used by companies that make products, including those in the manufacturing, technology, aerospace, transportation, telecommunications, agricultural and food, and construction sectors. Companies that don’t make a product use the term cost of sales instead to refer to direct costs.

COGS can be easily 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 of inventory in stock at the end of an accounting period.

In summary, COGS is a critical metric for businesses that make products, as it helps determine gross profit and gross margin. It includes direct costs such as raw materials and labor, but not indirect costs such as office expenses or marketing costs. COGS can be manipulated, so it is important to calculate it correctly.