Cogs vs Operating Expenses: The Vital Differences

Marketing 8 minute read 27th September 2023

Understanding the difference between COGS (Cost of Goods Sold) vs operating expenses is crucial for managing your business finances.

COGS refers to the direct costs linked to making specific products. Think of it as the expenses directly related to production, like materials and direct labor. Operating expenses, on the other hand, cover a wide range of day-to-day costs needed to run your business.

This includes things like rent, storage costs, utilities, office supplies, marketing, and shipping costs.

Knowing how to separate these expenses helps you create accurate financial statements, which are fundamental for a stable business. This knowledge empowers you to make informed decisions and plan for profitability.

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Top Differences Between Cogs vs Operating Expenses

Let’s examine some top differences between cogs and expenses. The best way to start is with a basic definition of each.

Cogs are the ‘cost of goods sold’ - e.g., all the direct costs of manufacturing a product. This would include things like raw materials and labor. However, it wouldn’t include costs like marketing, distribution, or cost of sales, just the creation costs of the physical products.

Operating expenses are much more inclusive. This is the total of your overhead costs, including administrative expenses, storage costs, and shipping costs. It can even include things like office supplies and insurance.

As you can see, cogs and expenses are two totally different expenses to calculate. So, let’s take a look at their main differences in closer detail:

  • Cogs is a product-specific calculation while expenses apply to the business as a whole.
  • Cogs factor in certain expenses, like raw materials for physical products. Expenses factor in dozens of different expenses, including administrative expenses and payroll and shipping costs.
  • Operating expenses are for estimating overall profit, while cogs are better at calculating the profitability of products.
  • Cogs are generally much quicker to calculate, whereas operating expenses can be time-consuming.

Why Should You Calculate Cogs and Operating Expenses?

Taking cogs and expenses seriously is pivotal for numerous reasons that significantly impact your business’s financial health and overall success. When making an income statement, these are all things you should deduct for tax. And whether you like it or not, you’ll need to get calculating - unless you hire an accountant.

However, tax aside, you should calculate cogs and expenses as they provide a more accurate depiction of profit turnover. It’s good to know exactly what you are making so that you can budget and make more informed business decisions. Knowing the average profit margin is also a good comparison point when calculating your expenses.

With all that said, let’s look at the top reasons why you should care about expenses and cogs:

  • They provide insight into the net profit, not the gross profit. This means you better understand your actual business profit and can budget accordingly.
  • They provide insights into your tax income statement so you can deduct accordingly. This is great because you can keep more of your profit and pay less tax.
  • They allow you to review your expenses and search for cheaper alternatives. For example, sourcing cheaper raw materials lowers the cost of physical products.

How To Calculate Your Cogs

Cogs is the term for the cost of goods sold. It includes the raw materials and labor costs to create the physical products. It does not include marketing, distribution, or cost of sales. With all that in mind, here is the calculation you need to work out your cogs for a product:

Beginning Inventory Value + Purchases - Ending Inventory Value = Cogs

This calculation looks strange. But we can break it down together. Say the beginning inventory value is $20,000, and you purchase $50,000 of inventory. You simply add these together.

At the end of the year (some people use months instead), you’d then calculate the value of your inventory again. If your inventory value were $40,000, costing $10,000 to purchase, you’d subtract $10,000 from the $70,000.

So, your overall cogs would be $60,000 for that year. See below:

$20,000 + $50,000 - $10,000 = $60,000

It’s pretty simple once you get your head around it, and if you get stuck, you can ask an accountant.

How To Calculate Your Operating Expenses

Remember us saying that calculating your operating expenses was trickier? Well, here’s why. To calculate your expenses, you need to know what your overhead costs are. Here’s how to calculate your operating expense vs cogs. For instance:

  • Rent
  • Staffing costs
  • Materials
  • Utilities
  • Advertising and marketing
  • Packaging
  • Distribution
  • Cost of sales

If you aren’t calculating your expenses for tax purposes, you should also include your tax expenses. You then total up all of these costs and subtract the total from your gross profit:

Gross Profit - Operating Expenses = Net Profit

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Final Thoughts: Moving Forward With Operating Expenses vs. Cogs

Navigating through the intricacies of operating expenses vs. cogs is an essential part of managing your business’s financial health. Taking these steps to understand and calculate these costs is a proactive move toward ensuring the stability of your venture. If you find yourself needing further guidance, seeking assistance from a qualified accountant is a wise decision.

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