Once operating revenue has been determined, the cost of goods sold must be calculated.  Cost of goods sold (COGS) is the cost of raw material bought and the production of the finished goods sold and the purchase price of inventory sold.  In manufacturing, COGS is the cost of goods purchased, raw materials, overhead and labor that can be directly related to the production of goods sold; in merchandizing, it is the purchase price of inventory sold.

COGS is a product cost, which is a variable production or manufacturing cost that can be apportioned to a good or inventory, comprising such costs as raw material, production overheads, depreciation on machinery and wages to labor incurred to create or acquire a product for sale.  Service companies generally do not have product costs.

The result of net sales minus cost of goods sold, which measures the firm’s profit (or loss) for the accounting period as a result of selling goods, without considering operating and nonoperating expenses, is the firm’s gross profit.  Gross profit is the operating revenue of a manufacturing or merchandising company and is the first profit measure in the multiple-step income statement.

Arriving at Gross Profit
      Net Sales
−    Cost of Goods Sold (GOGS)           
=    Gross Profit

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