What is COGS? The Ultimate Beginner's Guide for Retailers

Getting up to speed with key retail costs can be the difference between growing and grinding to a halt. Enter your Cost of Goods Sold. 

For anyone planning to start a new retail business, this article will give you a primer on Cost of Goods Sold (COGS). With the help of industry experts, we’ll answer retailers’ common questions about this useful accounting measure. We will cover:

• What COGS means in retail
• What’s included in COGS
• Why COGS and gross profit are (very) different
• How COGS and operating expenses differ
• How you can calculate your COGS
• What new retailers often get wrong about COGS
• How you can manage your COGS
• Brick-and-mortar vs ecommerce COGS
• What’s happening industry-wide with COGS

What does Cost of Goods Sold (COGS) mean in retail?

For any absolute beginners reading this, let’s start with a brief definition. 

COGS or cost of goods sold refers to any cost that goes directly into products sold by a manufacturer or retailer.  

“COGS are typically those expenses that are directly attributable to the acquisition of inventory and bringing it to the location of sale. That usually includes the cost of the inventory, freight, duties, shipping, and packaging,” said Abir Syed of UpCounting. 

What’s included in a typical retailer’s COGS?

Your retail business might be a lot different than others, but these are some of the most common costs included in retail COGS.

• The wholesale cost of products
• Raw materials for manufacturing
• Costs for parts to make a product
• Factory labor costs
• Shipping and freight costs
• Storage and container costs
• Manufacturing site overheads

COGS vs gross profit: what’s the difference? 

“By understanding COGS and gross profit, a retail business owner can better gauge how to price the merchandise they sell,” said Jessica Distel, director of business services at Buckingham Advisors. If you’re brand new to these concepts, here’s how to tell the difference. 

Understanding COGS

As we explained earlier, COGS is a variable cost showing how much you spent on the merchandise before selling it to your customers. 

Understanding gross profit

Gross profit is your revenue—the income you are left with after deducting your total COGS and operating expenses, and before you even begin to consider tax. 

• The difference between the retail price customers pay for your products, and your COGS is your profit margin. 
• Similarly, the difference between the retail price you receive for a specific product and the COGS is your product margin.

Understanding profit margin

COGS can have a huge impact on a retailer’s profit margins because it is usually the biggest overall expense category for most brands, according to Ryan Turner, founder of Ecommerce Intelligence, an email marketing agency. “Optimizing COGS and looking for ways to reduce spending—without impacting product quality—can have a large positive impact on your bottom line,” he said.

COGS vs operating expenses

One thing to keep top of your mind is that COGS are tied to sourcing or making your products and bringing them to where you will sell them. They are not part of your operating expenses. 

“For retailers, COGS or inventory is typically the largest ongoing expense in the business,” said Lee Whitaker, a senior manager at retail and wholesale consultancy, the Parker Avery Group.  “All other expenses will fall into operating expenses or capital expenditures.” 

Operating expenses are a much larger bucket, said Hillary Senko Cullum, a wholesale and retail consultant operating at HSC Advisors.

“Operating expenses encompass much more than just the cost of inventory. [Operating expenses cover] everything required to run the business from paying rent, to utilities, to payroll. The COGS is a type of expense that is tied directly to the product being sold, while other expenses are the cost of running and operating the business.

How do you calculate COGS?

COGS is affected by a wide range of factors. And that’s why it can be hard to calculate and forecast correctly, said Ecommerce Intelligence’s Turner. “The cost of raw materials and manufacturing, employees involved in fulfillment, shipping, and freight prices all impact COGS. Price fluctuations in any of these categories will often impact COGS,” he said.

COGS formula

You can use a formula to work out your COGS. 

To use the formula, you will need:

• The value of your starting inventory. This is the dollar value of items you have in stock and ready to use or sell at the start of an accounting period, like a month, or quarter.
• The value of your purchases. This is the dollar value you spent on the COGS examples we gave earlier, such as raw materials.
• The value of your ending inventory. This is the dollar value of your remaining inventory at the end of the accounting period mentioned above. You can do an inventory count to arrive at this value. 

Once you’ve confirmed these figures, here’s the formula you use. 

(Starting Inventory + Purchases) – Ending Inventory = Cost of Goods Sold

What do new retailers often get wrong about COGS?

One of the most common mistakes made when calculating COGS is either overstating or understating inventory levels and not reflecting the correct amount of inventory a retailer has paid for or is keeping as inventory. “This is very easy to do,” said Turner, “but it makes a big difference to a brand’s accounting because it may significantly affect the overall profit and loss by either inflating profits or making them look lower than they actually are.”

How can you manage COGS?

One way to keep COGS within reason is to look backwards and forwards through your accounts regularly. Syed suggests retailers get bookkeeping done regularly to monitor how expenses are trending relative to how much they’re making.

“That way if things aren’t going in a favorable direction you can quickly react to it,” he said. “The key to doing this well is checking your actuals versus forecasted each month to identify how well you forecasted—and to improve future forecasts. When you get better at forecasting you can make more confident decisions,” he said. 

Brick-and-mortar vs ecommerce: how can COGS differ?

Brands with brick-and-mortar stores will usually have additional expenses which will need to be included in their total COGS. These will usually be related to labor and operational costs necessary to get products into the hands of customers, said Turner. 

“Examples could be additional staff employed at a retail location, rent paid for brick-and-mortar stores, along with other expenses such as utilities. Brands that sell solely via ecommerce have fewer expenses in these categories in most cases, as they do not have costs related to running and maintaining physical locations.”

What’s happening with COGS across the retail industry? 

Senko Cullum said she is seeing examples of COGS increasing by as much as 10%, driven by global inflation and supply chain limitations. “Inflation costs have increased the cost of raw materials, manufacturing, shipping and transport, all of which flow into the cost of creating a product.”