Understanding Gross Margin and Cost of Sales

In contrast, the cost of sales calculation indicates the number of goods sold. While some businesses only report COGS or cost of sales on their balance sheets, others report both. Because you use them frequently interchangeably, it can be difficult to tell how they’re different. Calculating cost of sales formula is relatively straightforward. That is once you understand what to include and exclude from the equation. Businesses may have different views about whether or not to count lease and energy expenses in their cost of sales.

  • While the cost of sales isn’t deductible, you can subtract COGS from gross receipts to calculate a company’s annual gross profit.
  • It gives you a general idea of your production costs in relation to your total revenue.
  • It also does not include any costs of the sales and marketing department.

Here are some of the most common acronyms that are found in the income statement. It is a metric used to determine the cost incurred in producing the goods or services for the end-user to buy. Our online training provides access to the premier financial statements training taught by Joe Knight. Cost of sales helps determine the net profit and keep track of the product’s performance in the market. The COGS calculation shows the number of things a company creates.

The cost of sales is also known as the cost of goods sold or COGS. Once you have your COS, you can then calculate your gross margin using the formula below. Financial Intelligence takes you through all the financial statements and financial jargon giving you the confidence to understand what it all means and why it matters. Ask questions and participate in discussions as our trainers teach you how to read and understand your financial statements and financial position. Let’s say a business has $5,000 in inventory at the start of the month.

What is cost of sales?

Start by adding up all direct and indirect costs incurred during the sales process. Once you have this total, you can divide it by the total revenue generated from sales to arrive at your COS. In conclusion, understanding COS is critical for financial management in any industry. It provides an revenue recognition principle accurate picture of the profitability of a company and helps in making informed decisions about pricing, product development, and marketing strategies. COS is also used to calculate gross profit and profit margins, which are key financial ratios used to measure the performance of a company.

Looking for training on the income statement, balance sheet, and statement of cash flows? At some point managers need to understand the statements and how you affect the numbers. Learn more about financial ratios and how they help you understand financial statements. The cost of sales does not include any general and administrative expenses.

They may also disagree about whether or not to count freight and warehousing. The most important thing is to settle on a definition that works for your business, and then apply it consistently. EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. EBITDA is a measure that looks at earnings before the non operational and non cash expenses are subtracted.

In other words, the cost of sales formula is critical if you want to successfully comprehend your company’s finances. Once you recognize your gross profit, you can evaluate how well you operate the production process and how much remaining income you’ll have to manage with other expenses. The sample income statement below shows the cost of sales for a retailer/wholesaler that purchased 10,000 units of a single product for $3.50 each and sold each unit for $10.

A more common consensus is that a profitable SaaS business model should have a gross margin rate of 80-90%. It means that your COS should only take up 10-20% of your total revenue. Your overall gross margin gives you an idea of your production costs in relation to your revenue. Use your gross margin rate to help you figure out how to grow your revenue faster than your COS. Some businesses may focus solely on production or service delivery when calculating cost of sales.


The company spent roughly $5,000 on raw goods, salaries, and delivery. Gross margin is the amount left after deducting the Cost of Sales from the total revenue. All content on this website, including dictionary, thesaurus, literature, geography, and other reference data is for informational purposes only. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. He is the sole author of all the materials on AccountingCoach.com.

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It is because cost of sales includes other charges whereas COGS concentrates on a company’s direct costs. Your overall gross margin gives you a general idea of the production costs in relation to your revenue. Businesses need to know the cost of serving customers in order to set competitive and profitable prices.

Profit margin is a key financial ratio used to measure the profitability of a company. It is calculated by dividing the net income generated by a company by its total revenue. COS plays a critical role in determining a company’s profit margin. By keeping COS low, a company can increase its profit margin without increasing revenue. This is achieved by reducing indirect costs such as marketing expenses and commissions.

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Other businesses might take more of a lifetime view by including expenses such as sales commissions, referral fees, and online transaction fees for accepting card payments. A manufacturer is more likely to use the term cost of goods sold. The cost of sales line item appears near the top of the income statement, as a subtraction from net sales. The result of this calculation is the gross margin earned by the reporting entity. But what’s the point of spending so much time examining sales costs?

Series B: How does revenue growth percentage affect your valuation?

Niko is a CFO and a financial advisor who is passionate about solving problems, data analysis, mentoring smart entrepreneurs and bringing clarity and focus in difficult situations. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice. While labor costs are typically easy to figure out, other costs can catch out beginners. Freelance teams that start out using their home as an office will enjoy good margins initially, but that will change when they have to pay office rent.

By keeping COS low, a company can increase its profit margins without increasing revenue, which is crucial for long-term success. Therefore, it is essential for businesses to regularly analyze their COS and take steps to reduce it where possible. Your gross margin is one of the key indicators of how profitable and scalable your business is. It gives you a general idea of your production costs in relation to your total revenue. The goal is to increase your gross margin rate as much as you can. Apart from that, knowing the gross margin of ALL your revenue streams and how they contribute to the overall gross margin will help you with budget and resource allocation.

There are 2 related meanings of the COS Business Word abbreviation. Our team of writers strives to provide accurate and genuine reviews and articles, and all views and opinions expressed on our site are solely those of the authors. We are committed to helping our readers make informed decisions about their finances, and encourage you to explore our site for helpful resources and insights. At Ablison.com, we believe in providing our readers with useful information and education on a multitude of topics. However, please note that the content provided on our website is for informational and educational purposes only, and should not be considered as professional financial or legal advice. If you require such advice, we recommend consulting a licensed financial or tax advisor.