The short version
- • COGS = beginning inventory + purchases + labor + materials and supplies + other costs − ending inventory.
- • On Schedule C, the labor line excludes anything you pay yourself — your time belongs in your price, not your tax COGS.
- • Count inventory at the start and end of the year. Getting ending inventory right is what makes COGS right.
What cost of goods sold means
Cost of goods sold is the cost of the products you actually sold in a period — not everything you bought. Wax sitting on the shelf at year end isn’t COGS yet; it’s inventory, an asset. It becomes COGS when the candle it went into is sold.
That’s why gross profit is sales minus COGS: it tells you what your products earned before rent, marketing and the rest of your overhead.
The formula
For a sole proprietor or single-member LLC filing Schedule C, Part III of the 2025 form walks through it line by line:
| Line | What goes there |
|---|---|
| 35 | Inventory at the beginning of the year (last year’s closing inventory) |
| 36 | Purchases, less the cost of anything taken for personal use |
| 37 | Cost of labor — not including amounts paid to yourself |
| 38 | Materials and supplies |
| 39 | Other costs |
| 40 | Add lines 35 through 39 |
| 41 | Inventory at the end of the year |
| 42 | Cost of goods sold: line 40 minus line 41 |
Line 33 asks how you value closing inventory: at cost, at the lower of cost or market, or another method you explain. Line 34 asks whether anything changed in how you count or value inventory between opening and closing.
A worked example
A small candle maker’s year, with round numbers:
| Line | Amount |
|---|---|
| Beginning inventory (Jan 1) | $3,200 |
| + Purchases (wax, fragrance, jars, wicks, labels, freight-in) | $18,500 |
| + Cost of labor (a part-time employee who pours) | $9,000 |
| + Materials and supplies | $1,100 |
| + Other costs | $400 |
| = Total (line 40) | $32,200 |
| − Ending inventory (Dec 31) | $4,700 |
| = Cost of goods sold (line 42) | $27,500 |
If this shop sold $61,000 of candles, its gross profit is $61,000 − $27,500 = $33,500, a gross margin of about 55%.
What counts — and what doesn’t
- Counts: raw materials, the freight you paid to get them in, packaging that ships with the product, and wages for people who make the product.
- Doesn’t count on Schedule C: what you pay yourself. Line 37 says not to include amounts paid to yourself.
- Usually not COGS: advertising, website and marketplace fees, office costs and shipping to customers — those are operating expenses. Ask your tax professional where a specific cost belongs for your business.
- Personal use: anything you took out of inventory for yourself comes off purchases (line 36).
Your own labor: price it, but don’t deduct it as COGS
This trips up a lot of makers. When you set prices, your own time absolutely belongs in your cost per unit — otherwise you’re working for free (see our cost per unit guide). But on Schedule C, the labor line excludes what you pay yourself. As a sole proprietor, your pay is what’s left after expenses, not a cost of goods sold.
Ending inventory is where COGS goes wrong
Every dollar you overstate in ending inventory understates COGS by a dollar, and the reverse. Count what’s on the shelf at year end — finished goods and materials — and value it the same way every year.
A system that tracks every receipt, batch and sale keeps a running inventory value, so the year-end count becomes a check rather than a scramble.
COGS vs. cost per unit
Cost per unit is a planning number: what one unit costs to make, used for pricing. COGS is an accounting number: the total cost of the units you sold in a period. If you know each product’s cost per unit and how many you sold, they should roughly reconcile — when they don’t, something was left out of one of them.
How GodKey MFG handles it
In GodKey MFG, cost of goods sold isn’t a year-end calculation. Each batch works out a cost per good unit from what you actually paid — freight included — and when you sell, that unit’s cost moves from inventory to cost of goods sold automatically. Your profit and loss shows real gross margin all year, and inventory has a running value. Talk to your tax professional about how to report it.
Questions
What is the formula for cost of goods sold?
Beginning inventory + purchases + cost of labor + materials and supplies + other costs − ending inventory. That’s how Part III of Schedule C (Form 1040) lays it out, lines 35 through 42.
Can I include my own labor in cost of goods sold?
Not on Schedule C. The cost of labor line says not to include any amounts paid to yourself. Your own time still belongs in your pricing.
Is shipping included in cost of goods sold?
Freight-in — what you pay to get materials to you — is part of the cost of those materials. Shipping to customers is usually an operating expense. Ask your tax professional for your situation.
What is the difference between COGS and cost per unit?
Cost per unit is what one unit costs to make, used for pricing. COGS is the total cost of the units you sold in a period, used for your books and taxes.
Sources
General information, not tax advice. Rules depend on your business — check with a tax professional.