Cost of Goods Sold vs. Expenses in QuickBooks: What's the difference?

Cost of Goods Sold (COGS) are the direct costs you incur to create the products you sell, like raw materials and direct labor. Expenses are the indirect costs required to run your business, such as rent and marketing. Mislabeling them in QuickBooks doesn’t just make your reports messy—it distorts your gross profit margin and can lead to overpaying or underpaying your taxes.

What is Cost of Goods Sold (COGS)?

Cost of Goods Sold, or COGS, represents the direct costs tied to the production of the goods a company sells. Think of it as the cost of everything that physically makes up your product. These costs are only recognized on your income statement when the inventory is actually sold, not when it's purchased or produced. This is a core accounting concept known as the matching principle, which aims to match revenues with the expenses incurred to generate them.

In QuickBooks, COGS is a specific account type separate from general operating expenses. Calculating it correctly is fundamental for determining your gross profit—the money you have left over from sales after accounting for the product costs. Your gross profit is calculated as: Revenue - COGS = Gross Profit. This figure shows how efficiently your business is converting raw materials and labor into profitable products.

Correct COGS tracking almost always involves proper inventory management. When you purchase inventory, its cost is recorded as an asset on your balance sheet. When you sell that inventory, QuickBooks moves the cost of that specific item from the inventory asset account to the COGS account on your profit and loss statement.

Examples of costs included in COGS:

• Cost of raw materials (the wood for a furniture maker, the flour for a bakery).
• Cost of finished goods purchased for resale (items a retailer buys from a wholesaler).
• Direct labor costs (wages for assembly line workers or craftspeople directly building the product).
• Supplies used in manufacturing.
• Shipping and freight costs to acquire raw materials or finished inventory.

What are Expenses?

Expenses, often referred to as Operating Expenses (OpEx) or Selling, General & Administrative (SG&A) expenses, are the costs a business incurs to stay in operation that are not directly related to creating a specific product. These are the day-to-day costs of keeping the lights on, marketing your products, and managing the company.

Unlike COGS, operating expenses are recognized as they are incurred, regardless of when sales happen. They are deducted from the gross profit to calculate your net income (or net profit), which reflects your business's overall profitability. The calculation is: Gross Profit - Operating Expenses = Net Income.

In QuickBooks, the Chart of Accounts has numerous default expense accounts, such as Advertising, Office Supplies, Rent or Lease, Utilities, and Professional Fees. This detailed categorization allows you to see exactly where your operational spending is going, which is vital for budgeting and financial control.

Examples of common operating expenses include:

• Rent for office space or a retail store.
• Utility bills (electricity, internet, water).
• Marketing and advertising costs.
• Salaries and wages for non-production staff (e.g., salespeople, accountants, administrative assistants).
• Office supplies.
• Software subscriptions.
• Insurance premiums.
• Professional fees (legal, accounting).

Comparing Cost of Goods Sold vs. Expenses

Understanding the distinction between COGS and operating expenses is fundamental to accurate financial reporting. Classifying a cost incorrectly can skew your profitability metrics and lead to poor business decisions. A high gross profit margin might hide wasteful operational spending, while misclassifying OpEx as COGS could make your product margins look worse than they really are.

Aspect

Cost of Goods Sold (COGS)

Expenses

Nature of Cost

Direct costs of producing goods or acquiring products for resale.

Indirect costs of running the business operations.

Timing of Recognition

Recognized only when the product is sold (matching principle).

Recognized as they are incurred, regardless of sales activity.

Location on Profit & Loss

Appears at the top; subtracted from Revenue to calculate Gross Profit.

Appears below Gross Profit; subtracted to calculate Net Income.

Link to Inventory

Directly linked. The cost moves from the Inventory Asset account to COGS upon sale.

Not linked to inventory. These are period costs.

Examples

Raw materials, direct-line labor wages, wholesale cost of resale items.

Rent, marketing, administrative salaries, utilities, office supplies.

Written Breakdown

The simplest way to decide where a cost belongs is to ask: "Is this cost directly required to create or acquire the specific product I am selling?" If the answer is yes, it's likely COGS. If it's a cost you would incur to operate your business even if you made zero sales in a period (like rent), it's an operating expense.

In QuickBooks, this separation is critical. When you run a Profit and Loss (P&L) statement, QuickBooks first calculates your Gross Profit by subtracting COGS from your Total Income. This tells you how profitable your core product offering is. After that, it lists and subtracts all your operating expenses to arrive at your Net Income, which is your true "bottom line" profit. Mixing them up gives you a false picture of both your product's profitability and your company's overall operational efficiency.

Which One Should You Choose in QuickBooks?

Your business model determines how you'll categorize most of your spending. The setup in QuickBooks should mirror your operational reality.

For Product-Based Businesses (Retail, E-commerce, Manufacturing)

If you sell physical products, you will have a significant COGS account. Proper setup is non-negotiable for an accurate P&L.

• What to Do: You need a robust inventory tracking system. QuickBooks Online Plus and Advanced plans include inventory management features. When you purchase items for resale or raw materials, you should post the expense to an Inventory Asset account, not directly to COGS or an expense account.
• How it Works in QuickBooks:
  1. Enable inventory tracking and set up your products as "inventory items."
  2. When you buy inventory, you record the purchase on a Bill or Check, using the inventory item you set up. QuickBooks automatically increases the value of your Inventory Asset account.
  3. When you sell a product using an Invoice or Sales Receipt, QuickBooks automatically does two things: it records the income from the sale and it records the COGS by moving the item's cost from the Inventory Asset account to your COGS account.
• Common Mistake: A frequent error is booking inventory purchases directly to a "Purchases" or "COGS" account when the item is bought. This immediately expenses the entire cost, which is incorrect under GAAP. It overstates your expenses in the period you bought the inventory and understates them when you eventually sell it, leading to volatile and inaccurate profit tracking.

For Service-Based Businesses (Consultants, Agencies, Freelancers)

Most service businesses have little to no COGS, because they don't sell a physical product. Nearly all of their spending will fall under operating expenses.

• What to Do: Your P&L will primarily show income and a list of operating expenses like advertising, software, salaries, and office rent.
• A Key Exception - Cost of Sales: Some service businesses have costs directly related to delivering their service to a specific client. For example, a marketing agency might hire a freelance photographer for a client project. This isn't a general operating expense; it's a direct cost of earning that specific revenue. While not technically "Cost of Goods Sold," some accountants create a group of expense accounts called "Cost of Sales" or "Cost of Revenue" and place them directly below the income line on the P&L. This acts like COGS and allows the business to calculate a gross profit on their services. In QuickBooks, you would do this by creating a main expense account (e.g., "Direct Costs") and then sub-accounts for things like "Subcontractor Fees" and "Project-Specific Software."

Final Thoughts

In short, Cost of Goods Sold covers the direct costs of making a product, while expenses cover the operational costs of being in business. Separating them correctly in QuickBooks is fundamental for any business owner or accountant who wants clear insight into profitability, from the per-product level all the way to the bottom line.

Getting your bookkeeping categories right is the first crucial step. However, clean books often reveal complex tax questions, such as how to properly depreciate manufacturing equipment or determine taxability for services across states. Instead of spending hours hunting through ambiguous forums or dense IRS publications, Feather AI delivers instant, citation-backed answers from authoritative tax sources, helping you shift confidently from accurate accounting to sharp, strategic tax planning.