Many businesses incorrectly categorize cost of goods sold as expenses in QuickBooks, which distorts their profit and loss statement and makes it impossible to calculate accurate gross profit margins.

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What is Cost of Goods Sold (COGS)
Cost of goods sold represents the direct costs associated with producing or purchasing what you sell. COGS includes materials, labor, and expenses directly tied to creating your revenue.
The key test: if the cost wouldn't exist without that specific sale, it belongs in cost of goods sold.

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COGS vs Expenses: What Goes Where
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Cost of Goods Sold includes:

• Raw materials and inventory purchases
• Direct labor for production or service delivery
• Subcontractor payments for specific jobs
• Shipping costs to acquire inventory
• Packaging materials

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Expenses include:

• Rent, utilities, and insurance
• Marketing and advertising
• Office supplies and equipment
• Administrative salaries
• General business overhead

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Industry Examples

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Manufacturing: COGS includes raw materials and production labor. Expenses include office rent and marketing.

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Retail: COGS includes wholesale merchandise costs. Expenses include store rent and advertising.

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Service Business: COGS includes subcontractor fees and project materials. Expenses include office costs and general marketing.

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Restaurant: COGS includes food and beverage costs. Expenses include rent and kitchen equipment.

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How to Set Up COGS in QuickBooks:

• Navigate to your Chart of Accounts
• Select "New" account
• Choose "Cost of Goods Sold" type
• Create accounts like Materials, Subcontractor Costs, and Direct Labor

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Why Proper Classification Matters

→ Accurate Gross Profit: Shows profitability before overhead expenses
→ Better Pricing Decisions: Understanding true costs helps set appropriate prices
→ Meaningful Analysis: Investors and lenders expect proper categorization
→ Tax Compliance: Ensures accurate reporting and potential timing advantages
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How to Clean Up Your QuickBooks
Review current expense accounts and move direct costs to appropriate COGS accounts.
Properly distinguishing between cost of goods sold and expenses transforms your QuickBooks profit and loss statement from confusing to actionable, giving you the insights needed for informed business decisions.