Start a business, Do your taxes, Save money

You have COGS? Sorry to hear that. Magic Rule #2

We can’t truly say we’re done with our Expense envelopes until we determine what kind of business we’re going to be operating.

There are really only two types: a service business or an inventory business. Well, I suppose there are three types because you can have a combination of these as well.

Here are some examples.

Service business:

“Bob’s Massages“. Bob has clients who pay him for the service of a massage. He doesn’t sell anything else. This is strictly a service business. He has no products that he buys wholesale and sells for a higher price.

Inventory business:

“Bob’s Aromatherapy Shop”. Bob’s hands start aching from giving too many massages. His doctor tells him he has to change his profession. He decides to buy a big bottle of nice smelling oil and puts it in a bunch of cute little bottles and starts selling them at a stand in the mall. He no longer has a service business. Now he has inventory.

And where there is inventory, COGS is sure to follow.

Though COGS is not an “expense” in any accountant’s mind, it does share some similarities. COGS is an acronym for COST OF GOODS SOLD, and like expenses, it is deducted from Gross Profits to arrive at a business’s Net Income.

If you run a service business, and you will never sell inventory or buy goods at wholesale to sell at a higher (marked up) price, then you can just forget all about these ugly COGS. Stop reading now. Go do something fun.

If, however, you suspect you will try to make some cool craft items from things you buy at the dollar store, and sell them on Rodeo Drive, I’m afraid COGS will be an essential part of your business. But don’t worry. All that is required to keep the COGS monster in its place is one more envelope for your shoe box. So grab one, write “Purchases” on it, and toss it into your hi-tech Accounting System…er, I mean shoe box.

This brings us to…

MAGIC RULE #2: If you have inventory in your business (or resale items) you will need to calculate COGS at year-end, therefore, create a “PURCHASES” envelope  for your shoebox. Then read my upcoming post titled “I’ve got COGS. Now what?

If you ONLY have a service business, go watch TV.

June 28, 2011 - Posted by | Running Your Business, Starting Your Business


  1. I beg to differ about COGS not applying to service businesses. COGS for a service business are all costs directly incurred in offering your service. So for a bookkeeping service for example employees or contractors performing the bookkeeping service would be classified under COGS, but rent, telephone etc would be operating expenses.

    Comment by Louise Eggleton | March 27, 2012 | Reply

    • Of course. You’re absolutely right. But since 90% of small service businesses do not have COGS, I thought I would try explaining it in a way that would be useful for that majority. One excellent point you brought up is the contractor payment category. When small service businesses contract out work to others, they can list the amount in the “subcontracts” category which is located in the COGS section of the Statement of Business Activites. I plan to do a post about the differences between “subcontracts” and “salaries, wages, and benefits” at some point in the future.

      Comment by jkswift | March 28, 2012 | Reply

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