Cost of sales

Cost of sales is the line in the income statement that gathers the expenses directly tied to the volume sold during the period. The key word here is "sold": costs are recognised not when the company incurs them, but when the goods with which they are associated are shipped or the related service is delivered.

How costs end up in this line

Until a sale takes place, the money spent is not treated as an expense but sits on the asset side of the balance sheet. Purchased raw materials and finished goods are carried as inventories, and part of the cost of creating an asset is added to its carrying value, a practice known as cost capitalisation. At the moment of sale, the accumulated cost of each unit of output is written off to cost of sales. This is why a business that produces "for stock" reports a modest cost of sales despite heavy cash spending, while a business selling off its stockpiles shows the opposite: an inflated cost of sales with no new cash outflow. The depreciation of production capacity also goes into this line: the equipment was paid for at some point in the past, but it wears out on precisely what is being sold now.

Which part of the statement it shapes

Cost of sales is the first item deducted from revenue, before any selling or administrative expenses. What remains after the deduction is gross profit; this then has to cover selling expenses and the administrative expense block, and only after that is operating profit left. Because of this order, cost of sales is the most sensitive line in the statement: a shift in raw-material purchase prices shows up here earlier than anywhere else.

Example: a retail chain

For a retailer, cost of sales is the purchase price of the goods sold, and it absorbs the overwhelming share of turnover. Magnit's revenue for the latest reporting period is 412 000 000, and the gross mark-up on that turnover is thin by the very nature of the business: a retail chain earns its money not from the margin on each unit but from how fast its inventory turns over. For a mining company the picture is reversed: the share of cost of sales in revenue is lower, but it is more tightly linked to the exchange rate and to tariffs.

Where the term simply does not exist

At a bank, an exchange or an insurer you will not find a "cost of sales" line in the accounts: there are no goods being sold, and expenses are structured differently, as interest payments, provisions and staff compensation. Comparing SBER with a manufacturer on this line is meaningless: identical names do not make the figures comparable. The second common substitution is to read cost of sales as the total of invoices paid during the period. It is not a cash outflow: the gap between the two lives in inventories and in accounts payable, and it has to be looked for in the cash flow statement.