Finances & Fundraising
COGS vs Expenses: What’s the Difference?

COGS vs Expenses: What’s the Difference?

Written by 
Pilot Team
November 21, 2022
COGS vs Expenses: What’s the Difference?

A common question we get from our CFO services clients is, how is the Cost of Goods Sold (“COGS”) different from Operating Expenses (“OPEX”)? They’re both about spending money to allow your business to function; are they just two terms for the same thing? Which is which, and why does it matter?

The short answer is that no COGS and OPEX are not the same thing. While they both constitute money your business is spending, they include different costs, giving you additional information about the health of your business. So let’s take a closer look.

COGS: Creating Your Product

Cost of Goods Sold (COGS), sometimes called Cost of Revenue (COR) or Cost of Sales (COS) in businesses that provide services rather than physical goods, covers the money your company spends creating and delivering its product or service. This includes everything that goes into making and delivering the product to your customers. It doesn’t include indirect or overhead costs like marketing or rent for your facilities.

If your business sells a physical product, your COGS is relatively straightforward. They include the cost of raw materials that go into the product, manufacturing labor to assemble the product, and shipping the product to your customer. 

For service businesses, COGS (or, more accurately, COR/COS) needs to be more apparent. After all, you don’t have raw materials or manufacturing costs. The principle remains the same; however: if the cost is incurred by rendering your service to customers, it’s included here. For example, suppose your company offers in-person services like coaching. In that case, your COGS/COR/COS might consist of things like the cost of paying your employees when they perform the service. In addition, your COGS might include web hosting if you offer digital services like SaaS.

Let’s look at a few examples.

Example: COGS for a Company That Sells Physical Products

Sample Bread is a bakery that sells daily bread selections, pastries, cookies, and other baked goods. In addition to its retail location, Sample Bread sells boxes of cookies online through its website, which it then ships to customers. Sample Bread’s COGS include:

  • Flour, sugar, eggs, butter, and various other baking ingredients
  • Wages for its bakers
  • Packaging for its finished baked goods
  • Shipping costs for fulfilling its online orders

Example: COGS for a Company That Sells Services

Sample Learning is an education-tech company that offers online learning tools. Customers can access pre-recorded lessons from certified teachers on various subjects through the Sample Learning app for a monthly subscription fee. Premium subscribers also receive some hours with an on-demand video tutor to give one-on-one guidance. Sample Learning’s COGS include:

  • Hourly rates paid to the on-demand tutors
  • Consulting fees paid to the teachers who participated in the pre-recorded lessons
  • Rates paid to the video production agency that filmed and edited the pre-recorded lesson videos
  • AWS hosting costs for app and service content

Operating Expenses: Running Your Business

COGS reflects the direct costs of creating and delivering your product – which is the reason you have a business in the first place. But as you know, a lot more goes into running a business than just creating a thing and selling it. The workers making your product or service need somewhere to work. The product needs to be marketed so that people want to buy it, and prospective buyers need their questions answered and their options explained. On top of that, the books need to be kept, the phones need to be answered; the taxes need to be paid. 

Your operating expenses (OPEX) reflect these indirect business overhead costs. Categories included in OPEX include facilities costs (rent, utilities, any on-site perks), marketing and sales costs, business insurance, administrative costs (legal fees, finance help), and headcount costs (salary, benefits, etc.) for those employees who are not associated with goods/services creation and delivery.  

Your operating expenses do not include the costs of acquiring or investing in assets. Whether purchasing a building to use as an office or upgrading your equipment, these costs are considered capital expenditures (CAPEX). While OPEX costs are related to your regular business operations or dispensable goods (e.g., office supplies), CAPEX costs are related to investments you make in assets that will add value to your business (e.g., building or non-leased vehicles) or have useful life (e.g., furniture). So, CAPEX is listed separately on your financial statements (statement of cash flows).

Example: OPEX for a Company That Sells Physical Products

Sample Bread’s operating expenses reflect the everyday costs of running a bakery:

  • Rent for the bakery retail location
  • Utilities for the retail location
  • Cleaning supplies for keeping baking areas sanitary
  • Maintenance fees for the ovens and other baking equipment
  • Wages for the retail clerks, who also package and ship online orders
  • Salary for the general manager
  • Business insurance, fire insurance, workers comp insurance
  • Recipe and equipment training for new employees
  • Fees for contract bookkeeping, tax, and payroll professionals
  • Ads on Instagram and Yelp promoting popular or seasonal baked goods

Example: OPEX for a Company That Sells Services

Sample Learning’s operating expenses reflect the costs of running the startup:

  • Rent for the HQ office 
  • Salaries for all employees not directly involved in product creation, including marketing, sales, HR, finance, management, facilities, and legal departments
  • Business and rental insurance
  • Utilities for the office
  • Coffee and snacks offered to employees in the office
  • Cost of PPC and offline advertising
  • Administrative software licenses (HR platforms, expense management, etc.)
  • Software tools for marketing and sales management (marketing automation, CRM, etc.)
  • Fees for contract bookkeeping, tax, and payroll professionals

COGS vs. OPEX: Why It Matters

It’s essential to understand the difference between COGS and OPEX because each tells you something different about the state of your business. For example, if your company burns too much cash, COGS and OPEX can help you zero in on what needs to change. 

COGS tells you how efficient you are at creating your product and factors significantly into your profitability. For example, your business might bring in a lot of revenue. However, if creating your product is very expensive, you might still have low gross profits, making it hard to cover your operating expenses. 

Suppose you find that your COGS is taking up a high proportion of your revenue. In that case, you know you can increase your profits by reducing your production costs. One option might be to lower your supplier costs – can you renegotiate your contracts or find less costly suppliers through a procurement exercise? Another option might be to explore tools or training to help your team work more efficiently and produce more without raising costs.

OPEX, on the other hand, tells you how efficient you are at running your business overall. If your OPEX is eating through your funds, you can consider ways to tighten up your day-to-day spending. For example, you might look at how much you’re spending on marketing and whether you’re getting an appropriate return on your investment. Other common ways companies reduce operating expenses are cutting back on facilities spending or pausing hiring plans.

At first glance, COGS and operating expenses may seem similar. Still, both provide distinct and crucial insights into the state of your business. Use them both to get a fuller idea of what you’re spending, why, and if you’re getting the correct value for your money.

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