What does the term "costs of goods sold" (COGS) encompass?

The term "costs of goods sold" (COGS) refers specifically to the direct expenses incurred in the production or acquisition of the goods that a company sells during a specific period. This includes costs such as raw materials, labor directly involved in production, and any other expenses directly tied to the creation of the product. Understanding COGS is crucial as it directly affects the gross profit of a business, which is calculated by subtracting COGS from total revenue.

COGS does not encompass total operational expenses, indirect costs, or total revenue. While operational expenses represent the overall costs required to run the business, they include overhead and administrative expenses, which are not directly related to production. Indirect costs, such as utilities and salaries of staff not involved in production, also fall outside the definition of COGS. Finally, revenue generated from sales refers to the total income before any costs are deducted, highlighting how COGS is a critical component in evaluating a company's profitability in relation to its sales activities.