Cost of sales formula: how to calculate CoS

Also known as the cost of goods sold (COGS), cost of sales (CoS) is the direct expenses a company incurs to produce goods or services. It’s a useful sales metric for understanding a business’s profitability and underlying efficiencies and informing decisions about how to grow or where to reduce costs.

In this guide, we explain:

• The formula for the cost of sales and how to tweak it for different business models
• The expenses included and excluded from the CoS
• How to calculate cost of sales with examples
• Why the CoS is an important metric for businesses

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What is the formula for cost of sales?

The standard formula for the cost of sales is:

Cost of Sales = (Starting Inventory + Purchases) – Ending Inventory

In this formula:

• The starting inventory is the value of your available stock at the start of the period, i.e., what’s left over from the previous period. So if you’re looking at the whole year of 2025, your starting inventory would be the stock recorded on the first of January.
• The ending inventory is the value of any stock left over at the end of the current period. So for the whole year of 2025, this would be the stock you have left on the 31st of December.
• Purchases include any costs associated with making or buying your stock during the specified period. If the timeframe is the year 2025, this means you’d consider all the relevant purchases made from January 1st to December 31st.

However, the standard formula changes depending on the type of business. Remember, your CoS represents the expenses incurred to produce your products or services, which depend on your industry and business model.

For example, services businesses don’t have physical inventory because their “product” is technically the services they provide. So, a services company would add up expenses related to providing its services to calculate its cost of sales. This may include sales commissions, the salaries of employees who deliver services, workplace and equipment costs, and any software subscriptions they require to do their jobs.

However, they wouldn’t include salaries for employees who don’t deliver services, such as their internal HR team. This is because these are operational expenses for the business—they’re not directly required to deliver the services.

If you’re unsure whether to include an expense in your cost of sales calculation, ask yourself: Would this cost exist if we didn’t produce this product or service? If the answer is yes, then you usually won’t include it.

What isn’t included in the cost of sales?

To recap, expenses directly associated with producing your products or services fall under the cost of sales. So what’s left? The remaining expenses may fall under:

• Operating Expenditures (OpEx). This includes expenses associated with running your business or maintaining a product, such as salaries for admin or support roles, or rent and utilities. You can read more about OpEx here.

• Non-operating expenses, such as interest payments, taxes, and legal settlements.

How to calculate cost of sales (with examples)

To recap, the cost of sales formula can be tweaked depending on the type of business. The goal is to make sure the formula you use accounts for the costs involved in producing your company’s products or services.

Here’s how you might use and adapt the formula to calculate the cost of sales for different businesses.

1. Example 1: Calculating the cost of sales for a manufacturing company

Let’s take a company that manufactures tables and calculate its cost of sales for the first quarter of 2025. Your inventory records start on 1st January, and end on 31st March. The value of your inventory will depend on the inventory cost method you use. Let’s say your company’s inventory and purchase data is as follows:

• Starting inventory (i.e., inventory you have on the 1st of Jan): £60,000

• Purchases (i.e., purchases made from 1st January to 31st March): £5,000

• Ending inventory (i.e., inventory leftover on 31st March): £10,000

The CoS for the first quarter of 2025 is thus: 60,000 + 5,000 - 10,000 = £55,000

2. Example 2: Calculating the cost of sales for an ecommerce company

Now, let’s consider an ecommerce retailer that purchases its inventory from a wholesaler. For this example, we’ll assume their inventory includes hats. Let’s say we want to calculate the retailer’s cost of sales for the year 2025, and its purchase data is:

• Starting inventory (i.e., inventory you have on the 1st of Jan): 0

• Purchases (i.e., purchases made from 1st January to 31st December): £15,000 (the company purchased hats from the wholesaler).

• Ending inventory (i.e., inventory leftover on 31st March): £7,500 (the company didn’t sell all its hats)

The CoS for the year 2025 is thus calculated using the formula:

Cost of Sales = (Starting Inventory + Purchased Inventory) – Ending Inventory

Cost of sales = 0 + 15,000 - 7,500 = £7,500

3. Example 3: Calculating the cost of sales for a services company

Let’s consider a services company now, like a marketing agency or a dog walking company. In this case, the costs involved in providing the services are mainly salaries, equipment, and workspace costs. This means the agency’s cost of sales could be calculated as follows:

Cost of sales: Salaries of Employees Providing Services + Cost of Facilities, including the workspace and equipment - Cost of Labour on Unsold Projects (this may include labour costs for projects that you haven’t invoiced a client for yet)

Now, let’s calculate the agency’s cost of sales for the first quarter of 2025, assuming they spent £500,000 on salaries, £200,000 on facilities, and have £100,000 as their cost of labour on unsold projects.

The agency’s CoS for the year 2025 is thus: 500,000 + 200,000 - 100,000 = £600,000

Why is cost of sales an important metric for businesses?

Cost of sales is an important metric that helps businesses assess profitability, make long-term decisions about the future of their offerings, and manage budgets and taxes. Additionally, tracking your CoS helps you keep a pulse on underlying efficiencies.

For example, if your cost of sales increases abruptly and significantly, you’d want to investigate the cause; maybe raw material prices have gone up, or you’re now spending more on labour. In contrast, it can also alert you to positive changes—e.g., maybe after optimizing a manufacturing process, your CoS decreased during the next quarter.

Here’s more on how the cost of sales metric helps businesses:

Determine profitability.

You can calculate your gross profit by subtracting your cost of sales from your revenue for the specified period. Gross profit is an important metric that indicates how well a business balances earning income and efficiently managing its labour and processes.

The most straightforward example of how gross profit indicates these underlying efficiencies is to consider a business that scales its production to meet rising demand. If it scales efficiently, your gross profit will increase. Otherwise, if scaling ends up eating into your margins—e.g., maybe you overhired to manage production—your gross margin will take a hit.

Manage taxes.

Expenses that fall under the cost of sales are typically tax deductible, underscoring the importance of accurately tracking the metric. If you over-or underestimate your cost of sales, it’ll impact how much tax your business pays.

Compare products and offerings.

By calculating the cost of sales for specific products or services offerings, you can compare their profitability and the efficiency of providing them.

Summary: Cost of sales

The cost of sales formula evaluates the direct costs involved in producing a company’s products or services. While the standard formula includes starting and ending inventory, and purchases made during the period, you can adapt the formula to better reflect the models of different businesses. For example, services businesses don’t have inventory, and the cost of some of their direct labour falls under its cost of sales.

For companies with physical inventory, you can usually find their cost of sales listed on their income statement. It’s typically the second entry after sales revenue, and it might be listed as cost of goods sold (COGS). The cost of sales is a useful metric for gauging underlying efficiencies, calculating profitability, and making long-term decisions to boost your business’s performance.

Also read:

• What is operating profit?
• Markup vs margin: what’s the difference?
• CapEx vs OpEx