What Belongs in Cost of Goods Sold (COGS)? A Guide to Understanding Your Margins

Understanding your numbers starts with understanding your margins. And margins start with one key figure: Cost of Goods Sold (COGS).

Cost of Goods Sold (COGS) is the direct cost of the goods or services your business sells during a specific period. These are the expenses directly tied to delivering your product or service. When COGS is tracked accurately, it gives you a clear view of your gross profit, which is your total revenue minus COGS.

Why does this matter? Because your gross profit offers the first real insight into how profitable your business truly is. If COGS is miscategorized or overlooked, your margins can be misleading. This makes it harder to price your offerings correctly, identify what drives profitability, or spot inefficiencies that need attention.

In this post, we’ll break down what belongs in COGS, what doesn’t, and how to set it up correctly so your numbers tell the full story.

What Is COGS, Really?

COGS isn’t just another line in your Chart of Accounts. It reflects what it actually costs to earn your revenue. Since it’s directly tied to the work you do, your COGS should rise when revenue increases and fall when business slows.

What Belongs in COGS?

For this blog, we’re focusing on service-based businesses, where COGS is often overlooked but equally important.

Common service-related expenses that belong in COGS include:

• Subcontractor or freelancer payments tied directly to client work

• Labor costs for employees directly delivering your service (billable hours)

• Software expenses billed per client or used exclusively for service delivery

• Materials or supplies consumed during service delivery (e.g., cleaning supplies or tools)

• Merchant or platform fees tied to service delivery (such as fees from online marketplaces or scheduling platforms)

A good rule of thumb: If you wouldn’t have incurred the cost without doing the client work, it likely belongs in COGS.

What Doesn’t Belong in COGS?

The following should be categorized as operating expenses, not COGS:

• Salaries for admin or management staff

• General office expenses or software used business-wide

• Marketing, advertising, and lead generation costs

• Rent, utilities, and internet

• Insurance and legal fees

While these expenses support your business, they don’t directly relate to producing your services and should not be included in COGS.

Exercise: Identifying COGS

If you’re unsure whether a cost belongs in COGS, ask yourself:

• Is this employee doing billable work for a client?

• Would I still have this cost if I didn’t take on this specific client or job?

• Am I using software tools or platforms specifically to complete client work?

• Are materials or supplies used directly in delivering client services?

If you answered yes to any of these, the cost likely belongs in COGS.

Final Thoughts

Understanding what belongs in COGS is more than just a tax detail, it’s a financial strategy. Accurate margins give you the confidence to price your work correctly, manage resources wisely, and grow with intention.

Not sure if your COGS setup is giving you the insights you need? Let’s take a look together. I’d love to help you clean up your books and gain real clarity on what your business is earning.