COGS: Definition, Benefits, and Step-by-Step Calculation

When running a business, you definitely want to know how much net profit you’re actually making from each product sold, right? To answer that, you need to understand one of the key components in your financial statements — and that’s COGS, or Cost of Goods Sold.

COGS isn’t just a number on paper — it’s the foundation for understanding how much it really costs to produce a product or service. Want to better understand its benefits and how to calculate it? Let’s dive into this article together, Sahabat Labamu!

What Is COGS?

According to Investopedia, Cost of Goods Sold (COGS) refers to the total direct costs incurred to produce or acquire the goods a business sells. In Indonesian, this is known as Harga Pokok Penjualan (HPP) or Cost of Sales.

These costs include raw materials and direct labor used in the production of goods — but do not include indirect expenses such as store rent, marketing costs, or administrative staff salaries.

In financial statements, COGS usually appears right below the revenue or sales figure. It plays a crucial role in calculating gross profit and gross margin. The higher the COGS, the lower the gross profit you earn.

That’s why understanding and accurately calculating COGS is essential. It helps you set reasonable selling prices, maintain profitability, and manage your business more efficiently.

Why Is COGS Important in Business?

COGS (Cost of Goods Sold) is more than just a line item on your financial report. Behind that number lies a crucial role in determining whether your business is financially healthy. By calculating COGS accurately, you can unlock several important benefits:

1. Set Realistic Selling Prices

Knowing your COGS helps you set reasonable prices that still generate profit. Without proper calculation, you might price your product too low and suffer losses — or too high and scare away customers. That’s why COGS is a vital foundation for your pricing strategy.

2. Calculate Gross Profit and Evaluate Earnings

Gross profit is the result of subtracting COGS from your revenue. The higher your COGS, the lower your gross profit. By understanding COGS, you can better evaluate how efficient your operations really are.

3. Manage Business Taxes

COGS is recorded as a business expense, which reduces your taxable income. The larger your COGS, the less tax you may have to pay. However, this must be balanced carefully — high COGS could also reduce your actual profit.

4. Improve Production Efficiency

Analyzing COGS allows you to identify which parts of your production process are the most costly — for example, expensive raw materials or inefficient labor. This insight helps you find ways to cut costs and improve operational efficiency.

5. Assess the Financial Health of Your Business

COGS can serve as an indicator of how well you're controlling your costs. If it continues to rise without a matching increase in sales, it could signal an issue that needs addressing. Keeping COGS in check helps your business maintain a healthy profit margin and long-term stability.

What Are the Components Included in COGS?

In general, the costs included in Cost of Goods Sold (COGS) are direct costs — meaning these expenses only arise if there is a production process or if goods are purchased for resale. If no product is made or sold, these costs don’t appear. Here are the key components:

1. Raw Materials

This includes the cost of raw materials used to create the product — from primary to supporting materials. For example: fabric for fashion products, wood for furniture, or food ingredients for a culinary business.

2. Finished Goods Purchased for Resale

If your business buys ready-made products (such as in retail or reselling), the purchase price of those goods is part of COGS. This also includes purchase discounts, product returns, or special supplier deals.

3. Direct Labor Costs

Wages paid to production staff — such as tailors, carpenters, or factory workers — who are directly involved in making the product, are part of COGS. This can also include bonuses or allowances tied to production.

4. Freight-In Costs

Costs for bringing in raw materials or goods from suppliers to your production site — including shipping fees, container costs, and fuel surcharges — are considered part of COGS.

5. Storage Costs for Raw Materials or Finished Goods

If you rent a warehouse to store raw materials before production or finished goods before sale, those costs are included in COGS — as long as they’re directly related to the product.

6. Other Production Costs (Factory Overhead)

Fixed expenses that are directly tied to production — like machine depreciation, equipment maintenance, and electricity in the production area — are counted as part of COGS. Even if these costs are consistent, they support the manufacturing process.

7. Product Packaging

Packaging costs that are part of the product itself, such as boxes, bottles, or labels, are included in COGS. Especially when packaging plays a role in the customer’s purchasing decision.

What’s Not Included in COGS?

Costs that are indirect, administrative, or not directly related to the production process should generally be excluded from COGS. Here are some examples of expenses that do not belong in COGS:

1. Distribution Costs to Customers

Shipping costs from warehouse to customers — such as delivery fees paid by buyers or courier services — are not part of COGS. These fall under operational or logistics expenses.

2. Office Rent and Utilities

Operational costs like office rent, electricity, and water for administrative spaces aren’t included in COGS, since office areas aren’t directly involved in production.

3. Advertising and Promotion Expenses

Marketing costs — including online ads, social media promotions, and banner placements — belong to selling expenses, not production costs, and are excluded from COGS.

4. Non-Production Employee Salaries

Salaries for administrative staff, HR, finance, and managers aren’t part of COGS, as they don’t work directly on product creation. Likewise, fees for professional services like legal consultants, accountants, or notaries fall under general and administrative expenses.

5. Other Non-Operational Costs

Any costs unrelated to day-to-day operations are excluded from COGS. Examples include loan interest, depreciation on office buildings, or large asset purchases (capital expenditures).

How to Calculate COGS?

To find out the net profit from selling a product, you first need to know how much it costs to produce that product. This is where COGS (Cost of Goods Sold) comes in — it tells you the total production costs involved in making the product.

In general, the formula to calculate COGS is:

COGS = (Beginning Inventory + Purchases During the Period) – Ending Inventory

To make it clearer, let’s break down the steps simply so you can apply them directly to your business.

1. Determine Beginning Inventory

Beginning inventory is the total value of merchandise available at the start of the accounting period. Usually, this figure is taken from the ending inventory of the previous period.

Example: At the beginning of January 2025, Pak Untung’s Furniture Store has 5 tables in stock that haven’t been sold yet, with each table valued at IDR 10 million.

2. Calculate Total Purchases During the Period

Add up all the costs of purchasing goods or raw materials made during the period. This also includes shipping fees, purchase discounts, and rebates.

Example: Throughout 2025, Pak Untung’s Furniture Store bought 10 more tables at the same price.

3. Determine Ending Inventory

Conduct a stock opname, or physical count, to find out the value of goods remaining at the end of the period. This number will be deducted from the previous total.

Example: At the end of December 2025, there are 3 tables left unsold.

4. Include Other Production Costs (If Any)

If you produce the goods yourself, add other direct costs such as production worker wages, additional material costs, and factory operational expenses directly related to production.

Example: In the case of Pak Untung’s Furniture Store, these costs are considered nonexistent because Pak Untung does not produce the tables himself — he buys them from suppliers.

5. Calculate COGS

Use the formula mentioned above to calculate COGS:

COGS = (Beginning Inventory + Purchases) – Ending Inventory

COGS = (IDR 50,000,000 + IDR 100,000,000) – IDR 30,000,000

= IDR 120,000,000

So, the COGS for the year 2025 is IDR 120 million.

By regularly understanding and calculating COGS, you can determine profit margins more accurately, set more appropriate selling prices, and of course, make your business strategies more efficient. Not only that, your financial management will feel more organized because you know exactly where your business expenses are going.

To make the process of recording and calculating COGS easier, you can download the Labamu app via Google Play or the App Store. Let’s make every business decision more measured and profitable!