Understanding Cost of Goods Sold for Services

With COGS, you can easily see the monetary value of the products or services you sell.

There’s a lot of information on your financial statements and it can be easy to breeze right over some of the numbers. But one number you don’t want to miss: cost of goods sold (COGS).

This number is important and isn’t just a number that you need to know to fill out your tax return. This number tells you how much you make from what you sell and it can help you see if your pricing is right.

But what if you don’t sell “goods”? Can COGS still be of use to you? Here’s what every service business needs to understand about cost of goods sold for services.

What Is COGS?

COGS sounds like an abstract topic, but it’s pretty intuitive when you spend a little time defining it. Think of your expenses as falling into two categories:

Costs that are directly related to producing a product or delivering a service Those that don’t directly relate to producing a product or delivering a service

That first category are your COGS, which are variable. If you don’t sell anything, you won’t have any COGS. You only have these expenses when you sell something.

Unlike COGS, operating expenses are indirect costs and don’t vary based on how much you sell. This includes things like rent, utilities, and marketing costs. No matter how much you sell, your rent won’t change.

If you’re looking at your expenses and you’re still not sure which would be classified as a COGS, there’s a simple way to work through it. Ask yourself, “Would you have to pay this expense whether or not you sold anything?” If you’d need to pay for it regardless, it’s probably not a COGS.

Why Is COGS Important?

There’s a lot to know when it comes to your financials, and you might be tempted to skip past a lot of it because you’re busy running a business. Taking time to sit down and calculate your COGS might fall to the bottom of your priority list.

Don’t skip past calculating and understanding your COGS. Here’s why:

It Can Be Used to Calculate Gross Profit Margin

An important KPI for small business owners to track is their gross profit margin and you just need two numbers to calculate it: revenue and COGS.

Your gross profit margin tells you how much money you have remaining after paying for the product that you sold. That gross profit margin needs to be high enough to cover all of your indirect expenses, like marketing and salaries. Tracking to see whether your gross profit margin increases or decreases over time can help you get a sense of the financial health of your business.

It Helps You Make Accurate Pricing Decisions

Getting pricing right is tough to do. Price it too high and you might have fewer customers. Price it too low and you’ll have trouble breaking even.

How do you know if you’re charging enough to cover your costs? Knowing your COGS can help. You’ll see exactly how much it costs to actually sell your product or service. As a result, you can estimate the volume you’ll need to sell to cover your other costs. If the amount you need to sell

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