COGS Formula — How to Calculate Cost of Goods Sold (With Examples)

The COGS formula is:

Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold

That single equation tells you how much it actually cost to produce the goods you sold during a financial period. And if you make products by hand — candles, soap, jewelry, pottery, food — it might be the single most important number in your entire business.

Get it wrong and you might be underpricing everything you sell. Get it right and you’ll know exactly where your money goes, which products actually turn a profit, and what to put on your tax return at year-end.

Let’s walk through the formula step by step, with real examples.

What Is Cost of Goods Sold?

COGS is what it costs you as a business to create the products you sell in a financial year. Not rent. Not marketing. Not Etsy fees. Just the materials (and in some cases, hired labor) that went directly into making the thing your customer bought.

If you make ceramic mugs, your COGS comes primarily from the cost of clay, glazes, and kiln supplies. If you sew dresses, it’s fabric, zips, buttons, and thread. If you pour candles, it’s wax, wicks, fragrance oils, and the vessel.

The more materials involved, the harder COGS is to calculate — which is why most makers either avoid it entirely or get it wrong. But here’s the thing: COGS is a primary factor in determining whether your business is actually profitable. Miss this number, and your pricing is just guesswork.

The COGS Formula — Step by Step

Here’s the formula again:

Beginning Inventory + Purchases - Ending Inventory = COGS

Three numbers. That’s all you need. But each one matters, so let’s break them down.

Step 1 — Find Your Beginning Inventory

Beginning inventory is the total dollar value of all materials and finished goods you had on hand at the start of the financial year (January 1 for most US businesses).

This number should match your ending inventory from the previous year — because December 31’s ending inventory becomes January 1’s beginning inventory. If you’ve been tracking inventory consistently, this should already be in your records.

What counts: raw materials (clay, wax, yarn, metal wire), work-in-progress batches, and finished products ready for sale.

Step 2 — Add Your Purchases

Purchases is the total value of all materials and goods you bought during the year. This includes:

• Raw materials (new batches of wax, fabric bolts, essential oils)
• Components you buy pre-made (clasps, hardware, pre-cut blanks)
• Shipping costs to get materials delivered to you (your “landed cost”)
• Any goods purchased for resale

Note that “purchases” here means purchases of production materials, not purchases of office supplies or equipment.

Step 3 — Subtract Your Ending Inventory

Ending inventory is the dollar value of everything you didn’t sell by December 31 — raw materials still on your shelves, half-finished batches, and completed products waiting for orders.

To get this number, you’ll need to do a physical count (or rely on a perpetual inventory system that tracks it automatically).

Read more: How to calculate your ending inventory

Step 4 — Do the Math

Plug in your three numbers and subtract. The result is your Cost of Goods Sold for the year.

If your beginning inventory was $5,000, you purchased $12,000 in materials, and your ending inventory is $4,000:

$5,000 + $12,000 - $4,000 = $13,000 COGS

That $13,000 is what it cost you to produce everything you sold during the year. This is the number that goes on your tax return and the number you use to calculate your gross profit.

Cost of Goods Sold Examples

Numbers make more sense with context. Here are two worked examples from typical maker businesses.

Example A — The Woodworker

A woodworker starts the year with $3,000 in lumber, stains, finishes, and hardware (Beginning Inventory). Throughout the year, they buy $7,000 more in materials (Purchases). By December 31, they still have $2,000 in unused materials on hand (Ending Inventory).

$3,000 + $7,000 - $2,000 = $8,000 COGS

That $8,000 is the direct material cost of every wooden product they sold that year.

Example B — The Soapmaker

A soapmaker begins the year with $2,500 in soap base, essential oils, lye, and colorants. Over the year, they purchase $5,500 in additional supplies. At year-end, they have $1,500 in unused materials.

$2,500 + $5,500 - $1,500 = $6,500 COGS

If you’re a soap maker looking for a hands-on way to track these numbers, our free soap making inventory spreadsheet calculates COGS, inventory values, and profit automatically from your batch and sales data.

Side-by-Side Comparison

COGS Components by Craft Type

The materials that go into your COGS calculation depend on what you make. Here’s a quick reference:

Shipping materials you use to send orders to customers (bubble wrap, mailer boxes) are not part of COGS — those are operating expenses.

How to Calculate COGS for Handmade Products

The standard formula works for any product business, but handmade makers face a few specific wrinkles.

You’re working with raw materials, not finished goods. A retail store starts with products it bought wholesale. You start with raw materials that get transformed — sometimes through multiple production steps — into something completely different. Your “purchases” line includes raw materials at varying quantities and price points, and your ending inventory must account for both unused materials and work-in-progress batches.

Batch production makes per-unit costing tricky. When you make 50 candles from a single batch of wax and fragrance, you need to allocate the total material cost across all 50 units. Most makers know their total material spend but can’t trace it back to individual products. A recipe-based costing system makes this automatic instead of manual.

Waste and yield loss matter more than you think. If your soap recipe loses 5% to lye during saponification, your effective yield is lower than your raw inputs. Accurate COGS means accounting for expected waste — not just what ends up in the finished product.

Presentation packaging is COGS. Shipping packaging is not. The branded box your jewelry ships in, the ribbon tied around a soap bar, the custom label on a candle — these are COGS costs because they’re needed to get the product into a saleable state. The mailer you ship it in? That’s an operating expense.

Once you’ve calculated your COGS accurately, you can see your real profit margins — and decide whether to adjust pricing, find cheaper suppliers, or change your product mix.

What to Include (and Exclude) from Your COGS Calculation

Costs That Belong in COGS

Your COGS should include everything that went into getting your product into a saleable condition:

• Cost of materials — What you paid for raw materials, including shipping to get them delivered (your “landed cost”)
• Presentation packaging — Jewelry boxes, labels, ribbons, branded wrapping
• Hired labor — Wages for employees (W-2) who directly produce your products
• Manufacturing supplies — Items consumed during production (disposable molds, sandpaper, gloves)

Costs That Do NOT Belong in COGS

These are operating expenses, not COGS:

• Your own labor (as the business owner)
• Outbound postage and shipping materials
• Workshop or studio rent
• Payment processing fees (Etsy, Shopify, PayPal)
• Software subscriptions
• Marketing and advertising
• Office supplies and general business expenses

The key question: would this cost exist if I didn’t make any products? If the answer is yes, it’s an operating expense. If no — it’s COGS.

COGS relates only to bringing goods to a saleable point. Everything else is an “indirect cost” in accounting terms.

Read more: The difference between direct and indirect expenses

COGS vs. Operating Expenses

These two get confused constantly, but they sit on different lines of your financial statements:

Getting this classification right matters for both your pricing strategy and your tax returns. Misclassifying COGS as operating expenses (or the reverse) can distort your profit picture and raise flags with the IRS.

How COGS Affects Your Gross Profit

Once you know your COGS, you can calculate gross profit — the money left after covering direct production costs:

Revenue - COGS = Gross Profit

Using our woodworker example: if they sold $20,000 worth of products and their COGS was $8,000, their gross profit is $12,000. That’s a 60% gross margin ($12,000 / $20,000).

Why does this matter? Your gross margin tells you how much of every dollar in sales is available to cover operating expenses (rent, software, marketing) and still leave profit. If your gross margin is too thin, no amount of sales volume will make the business sustainable.

Most handmade businesses should aim for a gross margin between 50% and 65%. If yours is below that, it’s usually a signal that you need to raise prices or reduce material costs. An accurate COGS calculation is the first step to figuring out which lever to pull.

Pricing software that ties directly into your COGS data helps you set and adjust prices based on real numbers rather than hunches.

Read more: How to calculate and improve your manufacturing profit margins

How to Reduce Your COGS

Knowing your COGS is half the battle. Reducing it — without cutting quality — is how you grow your margins. Here are practical ways makers do it:

Buy materials in bulk. If you know your monthly wax consumption is 50 pounds, buying 200 pounds at a time usually brings the per-pound cost down significantly. Just make sure you have storage space and that the materials won’t expire.

Negotiate with suppliers. Once you’ve been ordering from the same supplier consistently, ask about volume discounts or loyalty pricing. Many small suppliers will work with you if you ask.

Reduce waste. Track your actual yield versus theoretical yield. If you’re losing 10% of your resin to mixing mistakes, that’s 10% added to your effective COGS. Better processes and tooling can close that gap.

Substitute materials where quality allows. Not every product needs premium-grade materials for every component. A less expensive base oil that performs identically in your soap formulation cuts costs without affecting the customer experience.

Tighten your recipes. Review your bill of materials periodically. Makers often keep using the same material quantities they started with, even after they’ve become more skilled and efficient.

Track everything. You can’t reduce what you don’t measure. The makers who consistently improve their margins are the ones who know their COGS per product, per batch, and per material — not just as a year-end total.

How Inventory Valuation Methods Affect COGS

The COGS formula is simple, but the value you assign to beginning and ending inventory depends on which cost flow method you choose. The three main options:

FIFO (First In, First Out) assumes you use your oldest materials first. When material prices are rising, FIFO gives you a lower COGS and higher reported profit — because the cheaper, older materials are what get counted as “used.”

LIFO (Last In, First Out) assumes you use your newest (and usually more expensive) materials first. This results in higher COGS and lower taxable income during periods of rising prices. Useful for tax savings, but LIFO is not allowed under international accounting standards (IFRS).

Weighted Average Cost averages the cost of all materials available during the period. This smooths out price swings and is the simplest method for most small businesses. If you buy fragrance oil at $8/lb in January and $10/lb in June, your weighted average cost for the year falls somewhere in between.

Whichever method you pick, you must use it consistently year to year. The IRS requires you to declare your inventory valuation method on your tax return, and switching without approval can trigger audit flags.

Read more: FIFO, LIFO, and Weighted Average Cost methods explained

COGM vs. COGS — What’s the Difference?

These two acronyms show up together constantly, but they measure different things.

COGM (Cost of Goods Manufactured) is the total cost of everything you produced during a period — whether or not it sold. It covers raw materials, direct labor, and manufacturing overhead for your entire production output.

COGS (Cost of Goods Sold) only covers the products that actually left your shelves during the period. If you made 100 candles but sold 80, your COGM covers all 100 while your COGS covers only the 80 that sold. The remaining 20 sit in ending inventory and will flow into COGS when they eventually sell.

For most small makers, the gap between COGM and COGS is small — you’re generally making to order or selling through what you produce. But if you batch-produce ahead of demand (say, building holiday inventory in September), the distinction matters for both your tax reporting and your cash flow picture.

Read more: The differences between COGM and COGS

How to Calculate COGS Without a Prior Ending Inventory

This trips up a lot of makers who are switching to the COGS method for the first time. If you’ve been expensing all materials directly for the last few years, you won’t have an ending inventory number from last year — so what do you use as your beginning inventory?

The standard approach: keep expensing materials directly until December 31 of the current year. At that point, your ending inventory is effectively $0 because everything has already been expensed. In the following year, your Beginning Inventory starts at $0, you calculate Purchases normally, and you do your first real physical count to establish an Ending Inventory.

From that point forward, you’ll always have a Beginning and Ending Inventory to work with.

One important caveat — talk to your accountant before making this switch. The transition from direct expensing to COGS-based reporting has specific rules, and your accountant can make sure you do it in a way that doesn’t create problems with the IRS.

How to Report COGS on Your Tax Return

In the US, how you report COGS depends on your business structure.

Sole proprietors and single-member LLCs report COGS on Schedule C (Form 1040), specifically Part III: Cost of Goods Sold. You’ll need six numbers:

• Line 35 — Inventory at beginning of year
• Line 36 — Purchases (less items withdrawn for personal use)
• Line 37 — Cost of labor (hired employees, not yourself)
• Line 38 — Materials and supplies (not already counted above)
• Line 39 — Other costs (manufacturing overhead)
• Line 41 — Inventory at end of year

The IRS subtracts Line 41 from the sum of Lines 35-40 to arrive at your COGS, which then gets deducted from your gross income on Line 4 of Schedule C.

Incorporated businesses (S-Corps, C-Corps) use Form 1125-A (Cost of Goods Sold) instead, which follows a similar structure but files separately.

Read more: Our step-by-step guide to Schedule C for makers

Why the COGS Method Matters for Makers

As a maker, the IRS sees you as a manufacturer — not just a seller. That distinction changes how you’re expected to report expenses.

The tax authorities expect a significant portion of your expense deductions to show up as COGS rather than operating expenses. If your numbers don’t reflect that — if you’re claiming $20,000 in “supplies” but $0 in COGS — it can look suspicious and invite closer scrutiny. For more on this requirement, see our guide to IRS inventory requirements for small makers.

Beyond tax compliance, there’s a genuine business advantage to tracking COGS properly — especially if you’re in the growth stage:

You can buy materials ahead without penalizing yourself. COGS lets you purchase materials in bulk or ahead of time and gradually offset costs against revenue as you use them. With direct expensing, the entire cost hits in the year you buy it, regardless of when you use it.

Here’s a quick example to show why this matters. Susan buys $10,000 of material stock in Year 1 but only uses $2,000 in production, leaving her with $8,000 in inventory.

If she expenses everything directly, the full $10,000 gets claimed in Year 1 against minimal revenue — not very useful. In Year 2, as the business grows and she uses that $8,000 of materials, none of it can be deducted because it was already fully claimed. That’s potentially thousands in lost deductions during the year she needs them most.

With the COGS method, Susan deducts only the $2,000 she actually used in Year 1 (Beginning Inventory + Purchases - Ending Inventory). The $8,000 carries forward as inventory and gets deducted in Year 2 when she sells the products made from those materials. The deductions match the revenue they generate.

Beyond taxes, here’s what accurate COGS tracking gives you:

• Accurate pricing. When you know exactly what each product costs to make, you can set prices that actually cover your expenses. Combined with your unit price calculation, COGS gives you the full picture of your production economics.
• Better product decisions. Some products that look like best-sellers might actually be margin-destroyers when you factor in material costs. COGS per product shows you which items deserve more shelf space and which ones need a price increase (or retirement).
• Cleaner tax preparation. The IRS requires COGS on specific forms. When your numbers are tracked throughout the year, filling out Schedule C Part III takes minutes instead of a weekend panic.
• Growth readiness. Knowing your COGS means understanding your margins. And understanding your margins is what lets you make smart decisions about expanding product lines, hiring help, or investing in equipment.

Common COGS Mistakes Makers Make

Even experienced makers get these wrong. Here are the ones we see most:

1. Including outbound shipping in COGS. The cost of shipping orders to customers is an operating expense, not COGS. However, the cost of shipping materials to you (your landed cost) absolutely should be included.

2. Forgetting presentation packaging. If you wrap your soap in branded paper or put your earrings in a custom box, that packaging is COGS — it’s required to get the product to a saleable state. The cardboard mailer you ship it in is not.

3. Switching inventory valuation methods mid-year. Whether you use FIFO, LIFO, or weighted average, pick one and stick with it. Switching without IRS approval creates problems.

4. Ignoring waste and spoilage. If you buy $100 of fragrance oil but 10% evaporates or gets spilled, your usable inventory is only $90. Not accounting for waste inflates your ending inventory and understates your true COGS.

5. Mixing up COGS and COGM. If you manufactured 100 candles but only sold 80, your COGS only covers the 80 that sold. The cost of the unsold 20 stays in ending inventory.

6. Not counting all materials. It’s easy to remember the big-ticket raw materials (wax, fabric, clay) but forget the smaller ones — wicks, clasps, glaze, thread. Those add up. The COGS components table above is a good checklist.

7. Claiming your own labor as COGS. Your labor as the business owner is not a COGS deduction. Only hired employees (W-2) count as direct labor in COGS. Your own time is an overhead — important for pricing, but not a tax-deductible COGS line item.

Free COGS Calculator

Want to crunch the numbers right now? Use our free COGS calculator. Enter your beginning inventory, purchases, and ending inventory to get your Cost of Goods Sold instantly — no sign-up needed.

For automatic COGS tracking as you record materials and production runs, Craftybase does the calculation in real time so you always know where you stand.

Software vs. Spreadsheets for Tracking COGS

Using spreadsheets to calculate COGS works when you’re starting out. If you’re an Etsy seller, our free Etsy pricing calculator spreadsheet is a practical starting point — it combines material costs, labor, and Etsy fees into a single profit calculation. For sellers with larger product catalogs, our multi-product Etsy fee calculator spreadsheet models up to 50 products at once.

But spreadsheets have a shelf life. As your product line grows and you’re buying materials from multiple suppliers at different price points, tracking it all manually gets time-consuming and error-prone. One mistyped cell formula or a forgotten material entry, and your COGS number — and everything that flows from it — is wrong.

The makers who run into the most trouble are the ones buying materials in bulk across multiple orders, producing different products from overlapping material pools, and trying to figure out per-unit costs at year-end from a spreadsheet that hasn’t been updated since August.

That’s the point where COGS software starts paying for itself. Craftybase is built specifically for small makers — it tracks your material purchases, ties them to recipes, calculates per-unit COGS as you log production runs, and generates the exact numbers you need for Schedule C Part III.

If you sell through WooCommerce, our guide to tracking COGS in WooCommerce covers what the platform can and can’t do natively. And if you use QuickBooks, our breakdown for small manufacturers explains where it works and where it falls short for makers specifically.

How Craftybase Calculates Your COGS

As we covered above, the IRS requires six figures for Schedule C Part III. Here’s where to find each one in Craftybase:

Inventory at Beginning of Year — Navigate to your Schedule C Guidance report, run it for the relevant date range, and use the number next to “Inventory at Beginning of Year.” Alternatively, pull this from the Material Valuation report (Starting Value column, Total Value row).

Purchases (Less Personal Use) — Same report, under “Purchases less cost of items withdrawn for personal use.”

Cost of External Labor — If you track hired labor as an overhead expense category in Craftybase, pull this from the Expense Category Report. Make sure to remove this amount from your Schedule C Part II to avoid double-counting.

Materials & Supplies — For any extra materials not captured in your start/end inventory totals, use the Expense Category Report. Again, remove from Part II if tracked here.

Other Costs — Same approach — use Expense Category Report for any production-related overhead tracked in Craftybase.

Inventory at End of Year — Schedule C Guidance report, under “Inventory at End of Year.” Or use the Material Valuation report (Ending Value column, Total Value row).

Frequently Asked Questions

Always consult with a tax professional or accountant for specific guidance on calculating and reporting your COGS. Rules and regulations vary by jurisdiction and business structure.