How to Determine Cost of Goods Sold (COGS) in Manufacturing

Cost of Goods Sold (COGS) is one of the most important metrics in manufacturing finance because it directly reflects how much it costs your business to produce the products it sells. It's the foundation for calculating gross profit and understanding how efficiently you're turning materials and labor into sellable products. Yet for many manufacturing leaders, especially those scaling operations or introducing new product lines, determining COGS is anything but simple.

This guide breaks down how to calculate COGS in a clear, practical way—while also covering why it matters and how it connects to broader financial strategy.

What Is Cost of Goods Sold (COGS)?

COGS refers to the direct costs associated with producing goods that were sold during a specific time period. It includes raw materials, direct labor, and manufacturing overhead that are directly tied to the production process. It does not include indirect expenses such as distribution costs, marketing, or administrative overhead.

In accounting terms, COGS is an expense deducted from revenue to arrive at gross profit:

Revenue - COGS = Gross Profit

Getting COGS right means more accurate pricing, forecasting, and budgeting—all of which are essential for manufacturing profitability and growth.

Why Is COGS So Important for Manufacturers?

Accurate COGS accounting offers more than just better profit calculations. It enables:

• Smarter pricing decisions
• Tighter inventory management
• Enhanced cost control
• Better financial forecasting
• Compliance with accounting standards and tax reporting

If you don’t know your true cost per unit, it’s impossible to identify which products are profitable, which need reengineering, or how volume shifts affect margins. In fact, manufacturers with detailed cost structures tend to outperform those without in areas like labor cost control, capital expenditure planning, and long-term sustainability.

Core Formula: How to Calculate COGS

The basic formula for COGS is:

COGS = Beginning Inventory + Purchases During the Period - Ending Inventory

While this formula seems straightforward, applying it in a manufacturing setting requires breaking down each component.

1. Beginning Inventory

This includes the value of all inventory on hand at the start of the accounting period. It includes:

• Raw materials
• Work-in-progress (WIP)
• Finished goods

2. Purchases During the Period

Any purchases related to production—such as raw materials, packaging, or parts—made during the period.

3. Ending Inventory

The value of unsold inventory at the end of the accounting period. Again, this includes raw materials, WIP, and finished goods.

Each of these elements must be tracked accurately through your inventory accounting system. For example, if ending inventory is overstated due to poor recordkeeping, your COGS will appear artificially low—leading to overstated profits and poor pricing decisions. For manufacturers using accrual accounting, proper timing of inventory inflows and outflows is key to matching costs with revenues correctly.

What’s Included in Manufacturing COGS?

Understanding which costs to include in COGS is vital for accuracy. Generally, COGS includes all direct costs:

Direct Materials

• Raw materials
• Components or subassemblies
• Freight-in (cost to get materials to your facility)

Direct Labor

• Wages of employees who directly assemble or manufacture products
• Payroll taxes and benefits directly related to production labor

Manufacturing Overhead (Allocated)

• Equipment depreciation
• Factory utilities
• Maintenance
• Factory supplies

The key here is to only include costs directly tied to production. Office rent, marketing spend, and executive salaries belong elsewhere on the income statement.

Using a well-structured ERP system helps manufacturers allocate overhead more precisely. With automation and detailed job costing modules, ERP platforms reduce guesswork and help you track COGS by product line or batch.

Per-Unit COGS: Finding the True Cost of Each Product

Calculating total COGS is useful, but unit cost is where insights really happen. Divide your total COGS by the number of units sold during the period:

Per-Unit COGS = Total COGS / Units Sold

This metric allows you to:

• Benchmark product profitability
• Adjust pricing strategies
• Optimize production processes

If you're planning for expansion or entering new markets, per-unit COGS plays a critical role in budgeting for manufacturing growth and understanding break-even points.

Periodic vs. Perpetual Inventory Methods

Your method of inventory tracking affects how you calculate COGS:

Periodic Inventory

• Inventory is counted at set intervals
• COGS is calculated at the end of the period
• Simpler, but less accurate in real time

Perpetual Inventory

• Inventory is updated continuously through software
• Real-time visibility into COGS and inventory levels
• Preferred for complex or high-volume manufacturing

Companies using periodic methods often miss fluctuations in labor or overhead costs because these are only accounted for at the end of the period. For instance, a sudden spike in labor rates during the month might not be visible until after the period ends. In contrast, perpetual inventory systems track changes continuously, providing real-time cost insights. This visibility empowers manufacturers to respond quickly and make informed adjustments to production, pricing, or staffing as needed.

Common COGS Pitfalls in Manufacturing

Even experienced manufacturers make errors in their COGS calculations. Here are some of the most common:

1. Misclassifying Costs

Confusing indirect costs (like office rent) with direct production costs leads to inflated COGS.

2. Ignoring Obsolete Inventory

Outdated or unsellable materials should be written down. Keeping them inflates ending inventory and understates COGS.

3. Failing to Allocate Overhead Accurately

Overhead like machine depreciation and factory utilities must be allocated based on logical, consistent methods.

4. Not Updating Labor Costs

Wages and benefits change. Periodic review ensures that labor cost calculations remain accurate.

How COGS Impacts Profitability

COGS has a direct effect on both gross profit and operating income. Lowering COGS (without sacrificing quality) increases margin, while rising COGS can quickly erode profitability.

Manufacturers focused on margin analysis often monitor COGS trends to evaluate efficiency, manage price changes, and prioritize process improvements. Especially when planning capital investments or forecasting growth, knowing your COGS trajectory can make or break strategic decisions.

COGS also connects to key performance indicators—metrics that help assess financial and operational health by revealing how well resources are being used to generate revenue. For clarity:

• Gross margin
• Contribution margin
• Fixed asset turnover

Each tells a story about operational health—and all start with accurate cost tracking.

Tools and Tactics to Manage COGS Effectively

While calculating COGS is essential, optimizing it is where financial strategy takes shape. Here’s how manufacturers manage COGS more proactively:

Implement Job Costing

Assign costs to specific jobs or batches. This helps compare actual vs. expected costs and spot inefficiencies early.

Use ERP Systems

Automated systems streamline inventory tracking, overhead allocation, and reporting. ERP integration improves data accuracy across finance, operations, and production.

Conduct Regular Inventory Audits

Routine counts help align system data with physical inventory, preventing costly errors or fraud.

Evaluate Supplier Relationships

Better terms or alternative suppliers can reduce material costs significantly—especially over long production cycles.

Standardize Production Workflows

Consistency reduces waste and variation, helping stabilize direct labor and overhead costs.

Beyond COGS: Using Cost Data to Drive Strategy

COGS isn’t just an accounting exercise. It’s a strategic lever. Understanding and optimizing your cost of goods sold supports:

• Capital planning: Informs decisions around automation, facility upgrades, or equipment purchases
• Labor strategy: Helps justify hiring or outsourcing decisions with real cost-per-unit data
• Budgeting for expansion: Aligns with how manufacturers structure and scale financial plans
• Tax planning: Improves visibility into deductions, especially when leveraging R&D tax credits or other incentives

Manufacturers that treat cost data as a strategic asset—rather than just a compliance requirement—can make faster, smarter decisions in every part of their operation. They’re better prepared to adapt to changing market conditions, defend margins, and identify investment opportunities that yield measurable returns.

Conclusion: Know Your Costs, Grow Your Business

Determining your Cost of Goods Sold isn’t just about meeting accounting requirements—it’s about gaining control over the financial engine of your manufacturing business. With accurate COGS, you can price smarter, forecast better, and make confident decisions across operations and strategy.

To take full advantage of your COGS data, consider investing in modern inventory systems, reevaluating supplier agreements, and reviewing cost structures regularly.

If you're expanding your product lines or scaling production, your ability to forecast accurately and control costs could be the deciding factor in long-term success.

Ready to take the next step? Contact the team at  Accounovation to explore how you can leverage precise COGS calculations, smarter cost strategies, and tailored financial systems to strengthen your manufacturing operations. Whether you’re fine-tuning your pricing, preparing for expansion, or improving profitability, we’re here to help you move forward with clarity and confidence.