The terms Cost of Goods Sold (COGS), Cost of Sales, and Cost of Revenue are synonymous. They describe the direct costs of producing a good or service that is sold to customers. In this post, let’s just refer to this as COGS.
Direct costs include direct labor and materials, and facility or plant overhead that is directly tied to producing the good or service. For example, the salary of a person assembling a television would be a direct cost. Extra electricity used to run a machine used only to produce the good or service would also be included.
But, the salary of the janitor at a plant that makes televisions, phones, and alarm clocks would be an indirect cost. The reason is that the cost of the janitor does not increase or decrease as a result of making more or less televisions. The amount of floor space to sweep in the facility is the same regardless of the number of televisions produced (within reason.) The janitor’s salary is an example of SG&A costs. SG&A stands for selling, general, and administrative. SG&A expenses occur when the company incurs an expense for
- Promoting, selling, or delivering products and services
- Managing the overall company
These types of costs will appear on the company’s quarterly (or annual) income statement for the period they were incurred. More specific examples of indirect SG&A costs include sales commissions, advertising and promotional materials, management compensation, compensation for support staff, rent, utilities, and office supplies.
The general rule is that direct costs do not include general overhead or administrative expenses. These expenses are not part of the COGS calculation.
COGS is key metric for cost analysis because shows the operational costs of producing a good and service. If cost of sales is rising while gross revenue is flat, net earnings (gross profit) will decrease. Remember that:
(Gross Revenue) – (COGS) = (Gross Profit)
Note that for a service business without a tangible, physical, product, COGS is a bit of a misnomer since there is not a “good.” That is why the term Cost of Sales is often used. But, the terms mean the same thing.