The direct expense a company incurs when making a product, or supplying a service, such as raw materials and labor are referred to as the cost of goods sold (COGS). Also referred to as the cost of sales, the cost of goods sold appears as a line item expense on the income statement.
Companies that maintain an inventory or keep raw materials on hand need to account for changes to beginning and ending inventories when calculating the cost of goods sold:
Goods Available for Sale = Starting Inventory + Additions to Inventory
Cost of Goods Sold = Goods Available for Sale - Ending Inventory
The cost of goods sold will not include indirect expenses such as research and development or selling, general and administrative expense (SGA). The COGS is an important value because it's often used when calculating efficiency ratios such as gross profit margins. Whenever drawing conclusions about the relative performance of a company, benchmark comparisons should be made with competitors in the same industry. This is especially true with a metric such as COGS.
The cost of goods sold typically appears as the first expense on the income statement, appearing just below revenues (sales).