What are direct costs of sales?

Direct cost of sales, or cost of goods sold (COGS), measures the amount of cash a company spends to produce a good or a service sold by the company. The direct cost of sales only includes the expenses directly related to production. The direct costs generally include direct materials, direct labor, utilities and shipping costs.

COGS is reported on a company's income statement and may be considered an expense. There are several ways to calculate COGS. One way is to add the cost of finished goods at the beginning of the period and cost of additional inventory purchased during the period minus the cost of finished goods at the end of the period. This calculation yields the total cost of goods sold during a specified fiscal period.

For example, suppose company ABC manufactures computer chips. ABC's direct costs include the materials to make the computer chips, the utilities to operate the machine that produces the chips and the labor costs used to put the chips together. However, the cost of training employees to deliver the chips or the cost of labor used to sell the chips is not included.

Suppose company ABC has $25 million worth of finished computer chips at the beginning of the year. Company ABC's cost of computer chips added throughout the year is $10 million. ABC has $8 million worth of inventory at the end of the year. The COGS for ABC is $27 million ($25 million + $10 million - $8 million). This figure is entered into ABC's income statement.