Cost of Goods Sold: What Counts When You Deliver Your Own Orders

Cost of goods sold is the direct cost of producing or buying the products you actually sold during a period. Flour and butter for the cases of croissants that left the building. The wholesale price of the stems in the bouquets you shipped. Not the ones still sitting in the cooler. COGS counts what sold, not what you made.

Get it right and you know your true gross margin, you price with confidence, and you claim a legitimate deduction that lowers your taxable income. Get it wrong and every margin figure you look at is fiction. The most common place small businesses get it wrong, by some distance, is delivery.

The Bottom Line

• COGS = beginning inventory + purchases during the period − ending inventory. It captures only what you sold.
• Direct materials and direct labor belong in COGS. Marketing, office rent and admin salaries do not.
• Freight-in, what you pay to get materials to you, goes into COGS. Freight-out, what you pay to deliver to customers, is normally a selling expense instead.
• That freight-out treatment is correct for accounting and misleading for pricing. Delivery is a real cost of each sale even when it sits below the gross profit line.

The cost of goods sold formula

Beginning inventory + Purchases during the period − Ending inventory = COGS

Start with what you had, add what you bought or made, subtract what’s left. What’s missing is what you sold.

An example. A florist opens the quarter with $9,000 in stems and supplies, buys $31,000 more, and counts $7,500 still in the cooler at quarter end. COGS is $9,000 + $31,000 − $7,500 = $32,500. If the shop booked $78,000 in revenue, gross profit is $45,500 and the gross margin is 58%.

Two things make this go wrong in practice. The first is inventory counts that are estimated rather than actually counted, because the formula inherits every inaccuracy in your ending inventory figure. The second is spoilage and waste. Stems that wilted and cases that were damaged left your inventory without generating revenue, and if you don’t account for them they quietly inflate COGS and hide a shrinkage problem behind what looks like a margin problem.

What belongs inside COGS and what doesn’t

The dividing line is directness. Did this cost attach to a specific unit of product, or did it keep the business running generally?

What belongs in COGS: raw materials and ingredients, products bought for resale, packaging that forms part of the product, direct labor for the people who actually make the goods, and freight-in on incoming materials.

What stays out of it: marketing and advertising, office rent, admin and management salaries, sales commissions, insurance, and professional fees. These are operating expenses and sit below gross profit on the income statement.

The one that generates the most argument is labor. A baker’s wages for the hours spent baking are direct labor and belong in COGS. The same person’s hours spent doing inventory admin, answering the phone or managing staff are not. Businesses that pay one person to do all of those things usually allocate by rough time split rather than trying to be precise, which is fine as long as the split is honest and consistent.

Note that some fixed costs land in COGS too. Production equipment depreciation and factory rent get allocated into product cost under standard manufacturing accounting even though they don’t vary with volume. Fixed versus variable and COGS versus operating expense are two different cuts through your expenses, not the same split under two names, and what makes a cost fixed works through that distinction.

Freight-in and freight-out: where delivery cost actually goes

Here’s the rule that catches almost everyone who ships their own orders.

Freight-in is what you pay to bring inventory and raw materials into your business. It’s part of the cost of getting inventory into its present location and condition, so it’s included in COGS. The delivery charge on your flour order is part of the cost of your flour.

Freight-out is what you pay to get finished orders to your customers. Under standard treatment this is a selling expense, not a product cost, and it sits below the gross profit line (AccountingTools). Your driver’s wages, the fuel, the courier fee. None of it touches COGS by default.

The treatment isn’t absolutely rigid. Delivery expense can be presented within the COGS line in some circumstances, and practice varies by business and by accountant. What matters is that you pick a treatment, apply it consistently, and know which one you’re using when you read your own numbers.

Why the accounting treatment will mislead your pricing

Here’s the practical trap. Because freight-out sits outside COGS, your gross margin looks healthy while your actual margin on each delivered order is meaningfully thinner.

Take a $60 case with $33 of materials and direct labor. COGS-based gross margin reads 45%, which looks comfortable. Now add $9 to deliver it. Real contribution from that order is $18, not $27, and the true margin is 30%. Price off the 45% figure and you’ll systematically underprice every delivered order.

This matters because delivery isn’t a rounding error. Small businesses paid roughly $8 to $21 per package in 2026, with surcharges adding another 30% to 40% (ParcelPath). On a $60 case, that’s up to a third of the price.

The fix is to keep two views. Use the standard treatment for your financial statements and your tax return. Then, for pricing and for working out how many orders you need to cover your costs, use a fully-loaded cost per order that includes freight-out. The break-even formula doesn’t care what your income statement calls an expense. If the cost moves with each sale, it belongs in the calculation.

Tracking delivery cost as its own visible line, rather than letting it disappear into general operating expenses, is what makes this possible. Businesses that bury it can’t tell you what an order costs to fulfill, which means they can’t tell you which orders are worth taking.

Inventory valuation: FIFO, LIFO and average cost

When your purchase prices change during a period, COGS depends on which units you count as sold.

FIFO assumes the oldest inventory sells first. In a period of rising prices it produces lower COGS and higher reported profit, and it matches how perishable goods actually move.

LIFO assumes the newest inventory sells first, producing higher COGS and lower taxable income when prices rise. It’s permitted in the US but not under international standards, and it makes little sense for perishables.

Average cost blends all purchases into one weighted figure. It’s the simplest to run and smooths out price volatility.

For food, floral and other perishable businesses, FIFO usually wins on the grounds that it describes reality. You do sell the oldest stock first, because the alternative is throwing it away. Whichever you choose, stay with it. Switching methods changes your reported profit without anything changing in the business, and tax authorities take an interest.

How COGS connects to the rest of your numbers

COGS is one input into a picture, and reading it alone is how businesses talk themselves into bad decisions.

Gross profit is revenue minus COGS. Subtract operating expenses, including the fixed overhead you owe every month and the freight-out that COGS excluded, and you get operating profit. A business can have excellent gross margins and still lose money, which usually means the problem is overhead rather than production. That’s a signal to look at reducing what you owe every month rather than squeezing suppliers.

The other connection worth making is to what a customer is worth. COGS tells you the margin on one order. It doesn’t tell you whether that order was worth winning, which depends on what you paid to acquire the customer and on how many more orders they go on to place. A thin-margin order from a customer who reorders monthly is a far better outcome than a fat-margin order from someone you never see again.

Frequently asked questions

Does cost of goods sold include shipping?

Incoming shipping does. Freight-in on materials and inventory you purchase is part of COGS. Outgoing shipping to your customers, known as freight-out, is normally recorded as a selling expense instead, though some businesses present it within COGS. Be consistent, and know which treatment you’re using.

Is cost of goods sold an expense or an asset?

Both, at different times. Inventory sits on the balance sheet as an asset while you hold it. The moment it sells, that cost moves to the income statement as COGS. Which is why unsold inventory never appears in COGS no matter how much you spent on it.

Can a service business have COGS?

It can have the equivalent, usually labeled cost of services or cost of revenue. It captures the direct labor and materials used to deliver the service. A pure service business with no inventory often has no COGS line at all, and that’s normal rather than an error.

How often should I calculate COGS?

Monthly if you can count inventory that often, quarterly at minimum. Annual-only calculation means discovering a margin problem up to twelve months after it started, by which point you’ve been pricing on bad information for most of a year.

Does COGS include labor?

Direct production labor, yes. Administrative, sales and management salaries, no. Split the hours of anyone who does both, and apply the same split consistently period to period.

Where to start

If you’ve never separated these costs properly, the fastest useful step is to calculate COGS for last quarter and compare your gross margin to what you assumed it was. The gap is usually instructive.

Then run the same numbers again with freight-out included, and look at what a delivered order really contributes. Most businesses that ship their own goods find the second number several points below the first, and find that the gap is widest on exactly the orders they were most pleased to win: the far-away ones, the small ones, the rush ones. That’s not an argument against taking them. It’s an argument for knowing what they cost before you decide what to charge.