COGS is a direct cost category that includes all expenses incurred to produce and sell a company’s products. It is subtracted from revenue to determine gross margin and profitability. The relationship between inventory and COGS varies depending on the type of business.
Cost of goods sold (COGS) is a component of a company’s inventory value. Inventory and cost of goods sold have a directly dependent relationship in practice and on the books. In practice, a company cannot have inventory without also having proportional costs that allow it to generate that inventory. On the books, COGS is subtracted from revenue to establish gross margin, or the amount of profit earned on the sale of the company’s inventory.
COGS is an expense category that compiles all the direct costs incurred to produce and sell a company’s products, or the direct costs of converting inputs into revenue. Depending on the type of business being studied, the relationship between inventory and cost of goods sold can be more or less complicated. For example, for a manufacturing business, this includes the cost of raw materials, the direct labor costs to produce the goods, the proportion of facility costs that can be directly allocated to the manufacturing process, and the direct cost of labor. used to sell the product. estate.
However, in a retail business, cost of goods sold is simply the cost of purchasing inventory from a wholesaler or manufacturer, the cost of preparing it for sale, and the cost of selling it. The relationship between the two in a manufacturing environment is somewhat more complex. It is generally easier in a retail environment to segment the appropriate costs that should be assigned to the COGS category.
The most relevant connection between inventory and COGS is the way in which both are related to establish the profitability of a company. Revenue is the amount of money a company receives as a result of the sale of its products. This number is important, but it does not reflect whether a company is making money or losing money. Profitability can only be determined once a business owner subtracts the costs incurred to generate that income.
At the most basic level, a business needs to know its gross margin, or the profit made from turning over its inventory before considering additional expenses like taxes. To figure this out, the cost of producing and selling inventory, or COGS, is subtracted from revenue. Inventory and cost of goods sold are inextricably linked in this analysis because the use of value for these two categories exposes basic business facts, such as whether an owner is pricing his or her property for sale at a level that benefits him or her.
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