Cost of goods sold is a financial accounting figure that is a part of business income statements. This figure represents the cost of all merchandise a business sold over a set period of time. By calculating the cost of all goods that had been purchased from a manufacturer and then resold, a business can figure out its gross profit on sales, and ultimately its net income. The cost to the business is the actual price that was paid to the manufacturer for the items.

There is a basic formula involved in calculating the cost of goods sold. Opening inventory, purchases, cost of goods available for sale, and ending inventory values are needed to come up with the figure on the income statement. The opening inventory is added to the purchases to arrive at the cost of goods available for sale — this is the cost to the business of all products offered for sale to its customers. Closing inventory value — the value of unsold stock still on hand at the end of the accounting period — is then subtracted from the cost of goods available for sale. The resulting figure is cost of goods sold — what it cost the business to sell the products customers purchased during this period.

Sometimes other elements are part of the cost of goods sold formula. These other elements include purchase returns and allowances. Other possible elements include purchase discounts and transportation-in.

Purchase returns and allowances occur when a business returns merchandise that has already been purchased because it deems the products to be unsatisfactory. Alternatively, the business may ask for a price allowance on the merchandise. Purchase discounts can occur when a business receives a cash discount for paying promptly for goods purchased on credit. Transportation-in is the transportation charges a business may pay to bring the goods to its premises.

Consequently, a modified cost of goods formula results. The modification is in the purchases portion of the equation. To arrive at a true purchase figure, a business would deduct any purchase returns and allowances, and purchase discounts it received from a supplier. Next, it would add in any transportation charges it paid to get the goods to its door. This becomes the real cost of purchases.

For a manufacturing business, its cost of goods sold is its cost of manufacturing — the cost of materials and labor required to make a product. This figure tells a manufacturing enterprise what it cost to create a product that it will sell to a go-between entity, such as a wholesaler or retailer. These entities then resell the product to other businesses or consumers, who are the end users of the product.