You've nailed the creative side of your business—whether you're producing music, designing graphics, or running an e-commerce store selling handmade goods. But when tax time rolls around, you're staring at your books wondering: "What exactly counts as Cost of Goods Sold?"
Here's the thing: understanding COGS isn't just accounting busywork. It's the difference between knowing whether your business is actually profitable or just spinning its wheels. Think of COGS as the bassline of your financial statements—it might not be the flashiest part, but without it, everything else falls apart. Get it wrong, and you're not just looking at incorrect profit figures; you could be overpaying tax or, worse, facing uncomfortable conversations with the Australian Taxation Office (ATO).
Whether you're a manufacturer tracking raw materials, a service provider billing for your time, or an online retailer shipping products across Australia, calculating COGS correctly is fundamental to understanding your true profitability. Let's break down this critical financial metric and show you how to track it like a pro.
Cost of Goods Sold (COGS)—also called "cost of sales" or "cost of revenue"—represents the direct costs your business incurs to produce or purchase the goods and services you actually sell during a specific period. It's not about what you bought; it's about what you sold.
COGS appears on your income statement directly beneath your revenue and is subtracted from your total sales to calculate gross profit. This makes it one of the most impactful numbers in your financial statements because it directly affects your bottom line.
Here's the critical distinction: COGS includes only direct costs—the expenses directly tied to creating your product or delivering your service. It doesn't include the rent on your office, your marketing budget, or your accountant's fees (though we're definitely worth it). Those are operating expenses, which we'll explore later.
The basic formula looks like this:
COGS = Beginning Inventory + Purchases During Period - Ending Inventory
For Australian businesses, COGS isn't just about understanding profitability—it's a legitimate tax deduction that reduces your assessable income. When calculated correctly and documented properly, COGS can significantly lower your tax liability. But the ATO requires meticulous record-keeping, so you'll need to keep those receipts and invoices organised.
Here's where it gets specifically Australian: GST implications. Australia's 10% Goods and Services Tax affects how you calculate and report COGS. If you're registered for GST (which you must be if your turnover exceeds $75,000), you can claim GST credits on purchases relating to taxable sales. This means your COGS components need to account for GST treatment properly.
The ATO requires written evidence for expenses over $82.50 if you want to claim GST credits, and your records must show the supplier's name, amount, nature of goods/services, and purchase date. Bank statements alone won't cut it.
The components of COGS vary dramatically depending on your business type. Let's break it down by business model because what works for a manufacturer won't apply to a graphic designer.
If you're making or selling physical products, your COGS typically includes:
For creative professionals, consultants, and service providers, COGS might be called "Cost of Revenue" or "Cost of Sales" instead. Components typically include:
Pure service providers like consulting firms, accountants, and lawyers may have minimal or no COGS if they don't use significant materials. However, trades and service businesses that use parts and materials (think plumbers, electricians, or recording studios) definitely need to track COGS.
For tech-focused creative businesses, COGS works differently:
Importantly, development costs are generally not included in SaaS COGS. Those brilliant features your developers are building? They're typically capitalised or treated as operating expenses, not COGS.
Understanding what not to include is just as crucial as knowing what belongs in COGS. These items fall under Selling, General & Administrative (SG&A) expenses:
The litmus test: Would this cost exist if you stopped producing products or delivering services? If the answer is yes, it's probably not COGS—it's an operating expense.
Common misclassifications include:
| Expense Type | Classification |
|---|---|
| Inbound shipping (freight-in) | COGS ✓ |
| Outbound shipping (freight-out) | Operating Expense |
| Factory/production facility rent | COGS ✓ |
| Office/administrative rent | Operating Expense |
| Production supervisor salary | COGS ✓ |
| Sales manager salary | Operating Expense |
| Raw materials for production | COGS ✓ |
| Office supplies | Operating Expense |
Here's where COGS gets interesting—and potentially strategic. The inventory valuation method you choose significantly impacts your reported COGS and, consequently, your taxable profit. Australia permits several methods under International Financial Reporting Standards (IFRS).
FIFO assumes you sell your oldest inventory first. During periods of inflation (and when isn't there inflation?), FIFO results in lower COGS because you're matching older, cheaper costs against current sales. This means higher reported profits and potentially higher tax bills.
FIFO is the most common method and generally reflects the actual physical flow of goods, especially for businesses with perishable items. It's permitted under IFRS and is widely used in Australia.
LIFO assumes you sell your newest inventory first. During inflation, this results in higher COGS (newer, more expensive costs matched to sales), which lowers your net profit and reduces taxable income.
Critical for Australian businesses: LIFO is not permitted under IFRS and therefore cannot be used in Australia. It's only allowed in the United States and Japan. If you're reading U.S.-based accounting resources, remember this distinction.
WAC smooths out price fluctuations by calculating an average cost per unit:
Average Cost Per Unit = Total Cost of Goods Available ÷ Total Units Available
This average is then multiplied by units sold to determine COGS. WAC provides middle-ground results between FIFO and LIFO and is particularly useful for high-volume businesses selling commodity-like products.
This method tracks the actual cost of each individual item sold. It's precise but administratively intensive, making it practical only for high-value items like jewellery, vehicles, or unique artworks. For most creative businesses dealing with volume, this method isn't realistic.
Key takeaway: Choose an inventory method that suits your business and apply it consistently. Switching methods arbitrarily raises red flags with the ATO and makes year-over-year comparisons meaningless.
COGS is the first and most significant deduction from your revenue, making it the primary driver of gross profit:
Gross Profit = Revenue - COGS
Gross Margin (%) = (Gross Profit ÷ Revenue) × 100
There's an inverse relationship at play: higher COGS means lower gross profit and margin. This metric tells you how efficiently you're producing or acquiring what you sell before considering any operating expenses.
Example:
For Australian businesses, accurate COGS calculation offers legitimate tax advantages. COGS is fully tax-deductible and reduces your assessable income. For tax purposes, the ATO allows a broader definition of COGS that can include certain indirect costs like storage, handling, and administration expenses, potentially reducing your tax liability further.
However, claiming these deductions requires meticulous documentation. The ATO requires you to maintain records for five years, including detailed invoices and receipts showing:
Your Business Activity Statement (BAS) lodgements will include COGS-related components, with GST on purchases reported and input tax credits claimed where applicable.
After working with creative businesses across Penrith and greater Sydney, we've seen these COGS mistakes time and again:
Treating operating expenses as COGS (or vice versa) distorts your gross margins and profitability. The fix? Use the test: "Would this cost exist if I stopped production?" If yes, it's likely an operating expense, not COGS.
When your physical inventory doesn't match your accounting records, your COGS calculation becomes fiction. Regular physical counts—at least annually, ideally quarterly—keep your numbers grounded in reality. Implement cycle counting for high-volume operations.
Many service-based creative businesses forget to include direct labour in COGS. If someone's billable hours are directly generating revenue, those wages belong in COGS. Track production hours separately from administrative time.
Material costs change, supplier prices increase, and your COGS needs to reflect current reality. Review COGS monthly or quarterly, monitor supplier costs, and adjust your pricing accordingly. Otherwise, you're selling at yesterday's costs with today's prices—a recipe for eroding margins.
Switching between FIFO, WAC, or other methods without solid justification makes your financial statements unreliable and raises compliance concerns. Choose your method thoughtfully and stick with it unless circumstances genuinely warrant a change (and document why).
Understanding typical COGS ratios helps you assess whether your business operates efficiently relative to industry standards. Here are approximate COGS-to-revenue benchmarks:
| Industry | Typical COGS % of Revenue |
|---|---|
| Retail | 50-65% |
| Manufacturing | 40-60% (varies by product) |
| SaaS/Software | 10-30% |
| Professional Services | 20-50% |
| Food Service/Restaurants | 28-35% |
These figures vary significantly based on business model, product mix, and operational efficiency. A SaaS business with 10-30% COGS enjoys high gross margins because software scales without proportional cost increases. Retail businesses typically run 50-65% COGS because they're purchasing finished goods and reselling them with modest mark-ups.
If your COGS percentage significantly exceeds industry norms, it signals potential issues with supplier pricing, operational inefficiencies, or underpricing. Conversely, unusually low COGS might indicate misclassification of expenses (shifting true COGS into operating expenses) or exceptional operational efficiency worth celebrating.
Cost of Goods Sold isn't just an accounting formality—it’s fundamental to understanding whether your creative business genuinely makes money or just looks busy. Like the rhythm section in a band, COGS provides the foundation upon which everything else builds.
For Australian creative businesses in 2026, accurate COGS tracking delivers multiple benefits:
The key principles remain consistent across business types: include only direct costs, maintain rigorous documentation, apply inventory methods consistently, and review regularly. Whether you're manufacturing guitar pedals in Penrith, running a design agency in Sydney's CBD, or operating an e-commerce store shipping across Australia, getting COGS right is non-negotiable.
Remember that COGS is reported through your BAS lodgements, requires GST consideration for registered businesses, and demands detailed records that survive ATO scrutiny. The effort invested in accurate COGS tracking pays dividends through tax savings, better business decisions, and genuine understanding of your financial performance.
Think of COGS management like mixing a track—everything needs to be balanced properly, each element must sit in the right place, and regular monitoring ensures the final product sounds exactly as intended.
Ready to crank your finances up to 11? Let's chat about how we can amplify your profits and simplify your paperwork – contact us today.
COGS represents the direct costs tied to producing or acquiring the goods or services you sell (like materials, direct labour, and manufacturing overhead), while operating expenses include indirect costs such as rent, marketing, and administrative salaries. This distinction influences how gross profit is calculated and how expenses are claimed on BAS lodgements and tax returns.
It depends on the type of service. Pure consulting or professional service firms may have minimal COGS since their primary expense is time. However, service businesses that require materials, parts, or subcontractors – such as electricians, plumbers, or recording studios – should track COGS (or Cost of Revenue) to ensure accurate gross profit calculation and to maximize deductions.
For GST-registered businesses (mandatory if turnover exceeds $75,000), the 10% GST must be taken into account. GST credits can be claimed on purchases related to taxable sales, reducing the effective cost. However, detailed evidence, including supplier name, amount, purchase date, and nature of goods/services, is required for expenses over $82.50.
While you can change inventory methods, any switch must be supported by a solid business rationale and comply with Australian Accounting Standards. Arbitrary changes can raise red flags with the ATO, and methods like LIFO are not permitted under IFRS in Australia.
The ATO requires detailed records for five years. For COGS deductions, you must maintain invoices and receipts that show the supplier's name, amount paid, nature of goods/services, purchase date, and the date the record was made. Bank statements alone are not sufficient.
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