Companies refer to either the cost of goods sold (COGS) or the cost of sales on the balance sheet, or in some cases both, leading to some confusion for investors about the meaning and implication of the two terms. However, fundamentally, there is almost no difference between a company's listed cost of goods sold (COGS) and cost of sales. The two terms are typically used interchangeably in an accounting context.
- Both the cost of sales and the cost of goods sold (COGS) measure the amount a business spends to produce or manufacture a good or service for sale to its customers.
- The terms are basically interchangeable and include the cost of labor, raw materials, and the overhead costs that are associated with running the production facility.
- Retailers, like toy stores, use the cost of sales, while manufacturers, like an auto parts supplier, use the cost of goods sold, since businesses that are service only can't list tangible items as operating expenses.
- Both terms are key reads on profitability—higher costs with flat revenue could mean costs are poorly managed, while higher costs and higher revenue, or flat costs and higher revenue, can imply good management.
The Cost of Producing a Product or Service
Cost of sales, also known as the cost of revenue, and cost of goods sold (COGS), both keep track of how much it costs a business to produce a good or service to be sold to customers. Both the cost of sales and COGS include the direct costs associated with the production of a company's goods and services. These costs include direct labor, direct materials, such as raw materials, and the overhead that's directly tied to the production facility or manufacturing plant.
Why the Cost of Sales and COGS Matter
The cost of sales and COGS are key metrics in cost analysis since they show the operational costs of the production of goods and services. If the cost of sales is rising while revenue has stagnated, it might be an indication that input costs have increased or other direct costs are not being appropriately managed. Cost of sales and COGS are subtracted from total revenue to yield gross profit.
Companies that offer both services and goods are likely to have both the cost of goods sold, and the cost of sales appear on their income statements.
When to Use Each Term
Retailers typically use the cost of sales, whereas manufacturers use the cost of goods sold. Since service-only businesses cannot directly tie any operating expenses to something tangible, they cannot list any cost of goods sold on their income statements. Instead, service-only companies typically show the cost of sales or cost of revenue. Businesses that might have no cost of goods sold include attorneys, painters, business consultants, and doctors.
Some service providers offer secondary products to their customers; for example, airlines offer food and beverages, and some hotels sell souvenirs. The costs associated with these items can also be listed as cost of goods sold.