Cost of Goods Sold (COGS) is one of the most miscategorized, and misunderstood, sections of your Profit & Loss statement.

If you’re throwing random expenses into COGS just to “make it look right,” you could be inflating your margins, overstating your expenses, and confusing your pricing decisions. Worse? It could cost you thousands in taxes.

So how do we fix this for you?

What are Cost of Goods Sold (COGS)

COGS includes only the direct expenses that exist because you made a sale:

• Inventory or raw materials
• Packaging and shipping (outbound only)
• Merchant processing fees tied to a sale
• Labor directly tied to fulfillment

These are your variable cost of goods sold. The more you sell, the more these increase. That’s not a bad thing, but if you don’t track them accurately, you can’t forecast them either.

This is where gross profit comes into play:

Revenue – COGS = Gross Profit
Gross Profit ÷ Revenue = Gross Margin

Your gross profit is what’s left before paying for your rent, admin staff, software, or ads. And if that number’s wrong? Everything downstream is wrong too.

COGS: Yes, It Impacts What You Owe In Taxes

COGS doesn’t just reduce your net income. It reduces your gross income, before your net is even calculated. That means it lowers your taxable income earlier in the equation, which can lead to meaningful tax savings.

But here’s the catch: your expenses must be properly categorized to get that benefit.

Misclassify overhead as COGS and you could be:

• Understating your profit margins
• Overpaying in taxes
• Getting penalized for inaccurate reporting

Accurate COGS Drives Smart Pricing & Forecasting

If your variable costs go up, for example, raw materials spike or your merchant fees increase, having your COGS categorized correctly helps you spot it fast.

This means:

• You can raise prices in time, without your profits taking a negative hit
• You’re not pricing based on gut feelings
• You’re planning ahead for busy seasons or scaling

I always recommend tracking COGS and overhead when building pricing models. If you don’t know your true cost, how do you know if your prices give you a cash reserves cushion?

COGS Helps Manage Inventory & Waste

Because it’s directly tied to fulfillment, COGS also reveals:

• Slow-moving or overstocked inventory
• Shrinkage or spoilage
• Seasonal cost spikes you can prep for
• Vendor contracts that need renegotiation

This keeps your warehouse (or digital shelves) efficient and your cash flow moving forward instead of getting stuck in unsold goods.

Final Thoughts from Your Favorite Bookkeeper 🧡

COGS isn’t just a bookkeeping section on your P&L, it’s also a financial strategy tool. When it’s clean, accurate, and consistent, it becomes the foundation of your pricing, tax savings, inventory planning, and for creating long-term cash reserves for scaling.

✅ Want help setting up your chart of accounts so your COGS and overhead are crystal clear? Hire My CFO as your bookkeeper!
📚 Prefer to DIY? Grab my book + workbook on Amazon to walk through the process step by step.
👉 Because at the end of the day, cash flow isn’t luck, it’s strategy 💼💰