Let’s take a few minutes to discuss two major cost categories from the perspective of an income statement, cost of goods sold, sometimes called COGS, and overhead. When an investor is reviewing your historical and pro-forma income statements they will want to understand which costs are necessary to provide the product or service you sell and which cost support your business from an administrative standpoint.

Cost of goods sold, many times called COGS for short, is the sum of all costs directly associated with the product or service your company provides. This could be items such as raw materials and labor for a manufacturer, the cost of inventory for a retailer or cost of delivering web based services for a technology company. Cost of goods sold is important to an investor because subtracting this number from revenue allows them to determine how much raw value, if you will, your product creates (called gross margin) and how much your company can afford to spend on overhead and still generate an acceptable return.

Overhead, sometimes called indirect costs, is the sum of all costs of doing business not directly associated with providing the goods and services your company sells. This could range from accounting costs to legal costs to insurance to rent to salaries for management. It is important for an investor to understand overhead so that they can determine how much cost can be curtailed in times of slumping sales or falling prices without compromising the base function of delivering goods and services.
A detailed understanding of cost is important for investor and manager alike so that your business can perform most efficiently and maximize return by continually eliminating excesses.

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