Financial Glossary
COGS vs. Operating Expenses
Cost of goods sold (COGS) and operating expenses are two distinct categories of business costs. COGS includes the direct costs of producing or delivering what you sell, such as materials, direct labor, and the cost of inventory sold, while operating expenses are the indirect costs of running the business, such as rent, marketing, software, and administrative salaries. On the income statement, COGS is subtracted from revenue to get gross profit, and operating expenses are then subtracted to reach operating income.
Problem & Application
Drawing the COGS line correctly matters because it determines your gross margin, a metric lenders, investors, and you yourself use to judge unit economics. For a campground, the cost of consumables sold at the camp store is COGS, while utilities and front-desk payroll are operating expenses; misclassifying them inflates or deflates margin and distorts profitability analysis. Service and hospitality businesses especially struggle with where to put labor, since some is direct and some is overhead.
In Short
Separating COGS from operating expenses is what makes gross margin meaningful and comparable over time. A consistent, defensible split is foundational to reading your own profitability.