Whether you’ve been perusing your company’s latest financial statements, digging into your business spending behavior, or simply brushing up on your financial knowledge, you’ve likely come across two distinct categories of expenses: Cost of goods sold (COGS) and operating expenses (OpEx).
What is the difference between COGS and OpEx? What kind of expenses fall into each category? And how should finance leaders interpret and understand each type of company expenditure?
In this article, we’ll provide answers to all of those questions before diving into practical guidance on how to calculate COGs and OpEx.
What are COGS and OpEx?
In business accounting, cost of goods sold (COGS) and operating expenses (OpEx) are distinct categories of costs, and understanding the difference between them is essential for accurate financial analysis.
COGS represents all the direct costs involved in producing or delivering the goods or services a business sells. OpEx are the ongoing costs a business incurs to run its day-to-day operations, excluding the direct costs of producing goods or services.
Clearly separating COGS from OpEx helps business leaders see true product profitability, control overhead, and make smarter decisions about pricing, budgeting, and growth.
COGS vs operating expenses (OpEx)
Both cost of goods sold and operating expenses reduce a company’s bottom line, but they do so in different ways, with different implications for financial reporting and for understanding profitability.
How they appear on financial statements
The first difference between COGS and OpEx is how they appear on financial statements.
COGS is deducted directly from revenue on the income statement, giving you your gross profit figure for the accounting period and giving insight into the efficiency of production or service delivery.
From there, operating expenses are subtracting from gross profit to calculate operating income, which reflects the costs of keeping the business running beyond production (but without considering interest and taxes).
Impact on profitability analysis
COGS tells business owners and finance leaders what costs go into producing a product or service. Subtracting this from revenue to understand gross profit allows leaders to understand profitability before considering overheads.
COGS is directly connected to profitability. A rising COGS without a corresponding increase in sales price, for example, signals shrinking margins.
Operating expenses capture broader costs like salaries, rent, and marketing. These expenses are still vital for daily operation, but don’t go directly into producing the product or service.
So, while OpEx doesn’t impact gross profit, it does play a central role in determining net profit. By reviewing the two figures in tandem, leaders and investors can understand how lean or heavy a company’s overhead structure is.
Reporting and compliance differences
COGS often comes with stricter tax and accounting rules, since it directly impacts taxable income. Businesses are required to carefully track which expenses qualify as COGS, such as raw materials, manufacturing labor, or shipping.
While OpEx is also regulated, there is often more room for discretion in classification, such as being able to allocate marketing spend across departments.
These differences matter because they influence how investors, tax authorities, and business leaders view financial performance. Clear separation of COGS and OpEx ensures accurate reporting, compliance, and sharper insights into both margins and efficiency.
Examples of operating expenses and COGS
Understanding the difference between COGS and operating expenses is easier when you look at a few common examples.
Examples of cost of goods sold (COGS)
Examples of direct costs tied to producing or delivering a product or service include:
- Raw materials and components
- Direct labor used in manufacturing or service delivery
- Packaging and shipping costs to customers
- Equipment or machinery directly used in production
Examples of operating expenses
Examples of indirect costs of running the business that are not tied to a specific unit of production include:
- Office rent and utilities
- Salaries for administrative, sales, and marketing staff
- Marketing and advertising campaigns
- Insurance, legal, and accounting fees
Importance of tracking COGS and OpEx
Accurate tracking of COGS and operating expenses does more than keep the books in order. It directly supports smarter financial management and long-term growth.
Effective expense tracking delivers three critical benefits.
1. Better budgeting and forecasting
By separating COGS from OpEx, you’ll improve spend visibility, allowing you to see exactly where money is good.
It also allows you to spot trends in production costs and overhead, allowing finance teams to create more accurate budgets and helping leaders plan resources more effectively.
2. Shaping pricing strategies
Understanding COGS is essential for setting prices that deliver healthy profit margins.
For instance, if material costs suddenly rise, you may need to adjust pricing or look to alternative suppliers to protect margins.
Similarly, monitoring operating expenditure helps ensure that overhead doesn’t erode profitability, despite strong sales.
3. Stronger business decision-making
Clear visibility into both spend categories empowers leaders to make more informed decisions about pricing, hiring, scaling, marketing investment, or new product development.
For example, knowing whether shrinking margins are due to rising production costs or increasing overhead helps you determine whether to focus on operational efficiency, renegotiating supplier contracts, or tightening up on discretionary spending.
Calculating COGS and OpEx
Accurate calculation and tracking are essential for using COGS and operating expenses as decision-making tools.
Here’s a quick overview on how to calculate both correctly.
Methods for calculating COGS
Calculating COGS for a given financial period requires using this simple formula:
COGS = Beginning Inventory + Purchases During the Period – Ending Inventory
Beyond this base formula, businesses often apply different inventory accounting methods, which can impact the final COGS figure:
- FIFO (First In, First Out): Assumes the oldest inventory is sold first, which often reflects current costs more accurately when prices rise.
- LIFO (Last In, First Out): Assumes the newest inventory is sold first, which can reduce taxable income during inflation but isn’t allowed under IFRS.
- Weighted Average Cost: Spreads the total cost of inventory evenly across all units, producing a stable, consistent measure.
- Specific Identification: Tracks the actual cost of each item, typically used for high-value or unique goods.
The choice of method affects reported gross profit, tax liabilities, and financial ratios, so it’s a strategic decision as much as an accounting one. What’s important is that you stick to the same approach to allow you to effectively compare COGS across periods.
Common tools for tracking OpEx
Operating expenses are often recurring, making finance automation especially valuable.
Accounting platforms such as QuickBooks and Xero can help you categorize and report overhead costs, while expense and spend management solutions like BILL Spend & Expense can help to:
- Streamline invoice capture
- Automate approvals
- Manage payments
Best practices for financial analysis
Understanding the difference between COGS and OpEx is an important first step, but knowing how to analyze changes in either is what helps you make more effective decisions.
Apply consistent categorization policies
Ensuring expenses are correctly categorized as COGS or OpEx is critical for ensuring your financial figures keep their value as decision-making tools.
Clear, documented policies prevent confusion and keep data accurate. Finance teams should define which costs belong in COGS versus OpEx, train staff on these rules, and apply them uniformly across the business.
Track expenses as a percentage of revenue
Looking only at dollar amounts doesn’t always give you the full picture.
A helpful method for financial analysis can be to track COGS and OpEx as a percentage of revenue, helping you to track margin trends over time and compare performance across different periods.
Review data regularly to spot trends
Financial data is most useful when it’s reviewed often.
Monthly or quarterly reviews are a good practice, which can help reveal cost creep or seasonal fluctuations before they impact profitability.
Use automation to improve accuracy and compliance
Manual expense tracking often leads to errors, delays, and incomplete records.
By automating these processes with spend management tools, you ensure greater accuracy and compliance, while saving time and cutting down on administrative overhead.
Financial operations tools with built-in automation, like BILL, can categorize expenses, flag anomalies, and generate reports in real time, making it easier to keep COGS and OpEx clearly separated.
