COGS: What It Is, Why It’s Not an Expense, and When Your Business Should Be Using It

January 23, 2026

Plenty of business owners scroll through their profit and loss statement, see “Cost of Goods Sold,” and assume it’s just another expense. But COGS — often shortened to COGS — is not just an expense category. It’s a measurement of what it physically costs you to generate revenue. And understanding COGS is one of the most powerful levers for pricing, margin control, and profitability.

COGS is not overhead. It’s not rent. It’s not marketing. And it’s definitely not the catch-all line where things go to disappear. COGS tells you how much it costs your business to create or deliver what you sell — and that distinction matters.

What Exactly Is COGS?

COGS stands for Cost of Goods Sold, and refers specifically to the direct cost of production or service delivery. These are the costs that scale as sales scale and drop when sales drop. If you sell more, your COGS goes up. If you sell nothing, your COGS should be nearly zero. That alone is what separates it from operating expenses.

COGS answers one important question:How much does it cost us to produce one dollar of revenue?

How COGS Differs From Expenses

Expenses keep the business running.COGS creates the product or service you sell.

Operating expenses cover things like rent, software, payroll for admin or sales staff, subscriptions, utilities, and marketing. These costs don’t change much whether you sell 10 units or 10,000 units — the lights stay on either way.

COGS, on the other hand, increases only when revenue is generated. It represents the materials, labor, and direct production inputs required to actually deliver your product or service. That means COGS sits above operating expenses in the P&L and has a direct impact on Gross Profit, which is the first real indicator of whether your pricing and production model is healthy.

If COGS is too high, gross margin is low — and even if revenue looks good, profitability may never follow.

What Types of Businesses Use COGS?

Not every company has COGS, but for the ones that do, it’s one of the most important metrics in financial reporting. COGS appears most commonly in:

Product-based businesses — manufacturing, retail, wholesale, ecommerce.These businesses have materials costs, packaging, freight into warehouse, and direct labor that physically produce or move inventory.

Food-based businesses — restaurants, bakeries, consumer packaged goods.Ingredients, kitchen labor, plating, raw stock — all roll into COGS.

Service companies with direct fulfillment cost — agencies, construction, trades, event production.If delivery requires labor tied directly to job execution, it may qualify.

COGS applies when a cost is linked to revenue generation itself. If you can’t make or deliver the product without it, it likely belongs in COGS.

Service businesses without direct labor tied to delivery — such as consulting or coaching — may not use COGS at all. Their costs are usually operating expenses, not production costs.

Where COGS Appears on the P&L

COGS sits directly under revenue at the top of the profit and loss statement. Revenue minus COGS equals Gross Profit, and Gross Profit divided by revenue gives you Gross Margin — one of the clearest indicators of pricing strength and product health.

This placement matters. It means COGS reduces profit before overhead, operations, payroll, marketing, rent, or administrative costs are considered. If your COGS is too high, no amount of revenue can save profitability without raising prices or improving efficiency.

Gross profit is where sustainability begins. COGS is the gatekeeper.

When you understand COGS, you understand pricing, profitability, and scalability.

COGS isn’t just an accounting term — it’s the foundation of margin control. It tells you what a sale costs you, how much you retain, and how much room you have to grow. Businesses that track COGS intelligently price with intention, protect margin, and scale without burning cash to do it.

If you want clarity around margin health, product cost structure, or P&L visibility, Outgrow Accounting & Finance can help break it down in a way that guides decisions — not just reporting.

Because numbers aren’t just data. They’re direction.