Many people have a difficult time understanding the difference between cost of goods sold (COGS), and operating expenses. It is normal to feel confused, after all, both are essentially money that is being spent from your business.
However, COGS and operating expenses are fundamentally different, and both show different things about your company’s financial health.
Whether you are a new business owner, or simply new to the world of accounting, it will benefit you to understand the difference between expenses and cost of goods sold.
What is the Cost of Goods Sold (COGS)?
The cost of goods sold (COGS), also sometimes referred to as cost of sales (COS), or cost of revenue (COR), refers to all the money your business spends creating and delivering your final goods or service.
This includes everything that goes directly into making the product and delivering it to your customers. For example, if you are producing shirts, then the cost of goods sold would include the cost of thread, cloth, dyes, wages for manufacturing labour, and whatever freight costs are included in the production or delivery.
It is very important to note that the COGS does NOT include indirect or overhead costs such as wages, rent, or utilities.
Simply put, the cost of goods sold accounts for all the direct costs of producing the actual goods or services that your business makes.
What are Operating Expenses (OPEX)?
On the other hand, operating expenses refer to all the indirect and overhead expenses that are involved in running your business (but not in directly producing the products).
As we all know, there is a lot more that goes into running a business apart from the production of your main service offering. Utilities, rent, salaries, marketing and advertising expenses, and legal fees are just a few of the many indirect expenses that your business will incur.
Therefore, when creating financial statements, operating expenses refer to all the overhead and indirect costs involved in your business.
What Do COGS and OPEX Tell You?
On one hand, the cost of goods sold tells you how efficient you are in making your product or service. You may have high revenues, but if the COGS is very high, it is possible that you will have low profit margins.
OPEX, on the other hand, tells you how efficient you are at running your business overall. If you find that operating expenses are skyrocketing, it may be due to extra expenses that are falling through the cracks, or that there are expenses that you simply cannot afford.
Investors will take a look at your financial records and assess both COGS and OPEX when performing their due diligence. Therefore, it is important to keep accurate records of both.
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