Let’s review the traditional COGS equation. It’s very easy to understand.

I call this the old-fashioned way to compute COGS since it's not the formula used by modern accounting software like QB. Even though it seems old fashioned, it's a good formula to memorize. Page two of the 1040 Schedule C (the tax return for sole-proprietors) shows it clearly.

1. Take the total cost value of your beginning inventory. This should be the same as the cost value of the ending inventory of the prior year.

2. Add the cost of inventory purchased during the year.

3. Subtract the cost of personally used items.

4. Subtract the cost of ending inventory.

If you are a manufacturer, also add wages you paid to people who actually worked to manufacture what you sell.

Add in other direct costs associated with the sale.

Business that just started have a beginning inventory of zero.

Working the COGS Equation

Take the beginning inventory, add the purchases, subtract any inventory used for personal reasons, and subtract ending inventory. This is the COGS for the year.

Important: always take a physical inventory at the end of the tax year!

Your year-end physical inventory counts provide a base-line from year to year, so you can compute COGS accurately.