The Art and Science of Profit: A Simple Guide to COGS and Your Chart of Accounts
When you look at your business finances, do you see a confusing wall of numbers or a clear roadmap to profit? Understanding how to categorize your spending is the difference between just getting by and truly growing your business.
Today, we are breaking down the two most important tools in your financial toolkit: Cost of Goods Sold (COGS) and your Chart of Accounts.
What is Cost of Goods Sold (COGS)?
At its simplest, COGS represents your direct expenses. These are the costs specifically tied to how you make your money. Your business has two kinds of expenses: direct and indirect.
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Direct Expenses (COGS): These are expenses directly tied to how you make revenue.
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The Granola Example: If you sell granola, your direct expenses are ingredients like cinnamon, honey, and oats.
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The Service Example: If you provide a service, your direct expenses are most likely labor costs.
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Indirect Expenses (Overhead): These are all the other expenses the business has to pay to stay open.
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Examples of Overhead: This includes costs like rent on your office, insurance, and administrative wages.
Why This Matters for Your Paycheck
The goal of separating these costs is to find your gross profit. You find this number by taking your total revenue and subtracting those direct expenses.
This is important because your gross profit is the bucket of money used to pay for two big things:
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All of your overhead and indirect expenses.
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Your own pay as the owner.
The Chart of Accounts: Your Business Map
Every accounting system uses a chart of accounts. Think of this as a master list of categories used to organize every single transaction in your business.
This list organizes things into groups like revenue, expenses, assets, and liabilities. Managing this list is partly a science and partly an art.
The Science: The Standard Rules
The science part is that the accounting industry has a standard way of organizing these lists. In every accounting system, you will see the categories in this specific order:
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Assets
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Liabilities
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Equity
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Revenue
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Cost of Goods Sold
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Expenses
The Art: Your Creative Freedom
The art part is that you have the power to choose what fits your business best.
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What counts as a “direct expense” in your business might be different than in another business.
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If a specific cost (like the rent for a studio) is a huge part of your product, you can choose to group it differently.
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You do not have to just accept the generic categories that software like QuickBooks gives you.
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Your chart of accounts is flexible, and that is where the accounting fun takes place.