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There is a lot of confusion created by the accounting profession over Costs. Even the HMRC roll all of the outgoings into one and they call that Expenses. In order to be able to have a good grip on your performance it is necessary to split the outgoings into three - Cost of Goods Sold, Expenses and Investment. This page will deal specifically with Cost of Goods Sold, more often referred to as COGS. The other outgoings are covered elsewhere
Whether you make and sell things or provide a service to your Customer there will be costs involved directly and indirectly in creating those goods and services. An example of Direct Cost would be those parts and materials that will actually belong to the buyer after the bill has been paid so if you make and sell a widget the parts and materials you have used, the labour you have paid for and any specific packaging used for each widget are all Direct Cost. Indirect Cost is that which is related to the making of the widgets but which cannot be ascribed to an individual widget, for instance, the energy expended in the manufacturing process, rental costs of premises and telecommunications both of which can be attributed exclusively for the manufacturing operation and other packaging used to ship a number of widgets and therefore are a shared cost across all the widgets made
Both these costs add up to the Cost of Goods Sold and are a most important factor in the determination of your Gross Profit
Comments and suggestions for improving this site are appreciated and should be addressed to administration
Last Update 28-Feb-2010
Date first published 07-Nov-2005