What does cost of goods sold (COGS) represent?

Cost of Goods Sold (COGS) represents the direct costs associated with the production of the goods that a company has sold during a specific period. This includes the costs of materials, labor, and overhead directly tied to the manufacturing of the products. It is a critical metric for understanding the profitability of a business because it reflects the expenses incurred to generate sales revenue.

When calculating gross profit, COGS is subtracted from total sales revenue, allowing a company to evaluate how efficiently it is producing goods and how much profit it is making on those goods after covering direct costs. This measure does not include indirect costs such as selling, general and administrative expenses, which are treated separately in the income statement. Understanding COGS is crucial for making informed pricing, inventory management, and financial analysis decisions.