Cost of goods sold refers to a deduction from gross income for the cost of producing or acquiring items sold by a business.
Here’s a simple example of cost of goods sold.
Company X sells widgets for $20 each. It costs Company X $5 to make the widget. If the company sells 1 widget, its tax return will show: $20 of gross income, minus $5 for cost of goods sold. This leaves $15 as Company X’s gross profit.
From gross profit, Company X will subtract out its other expenses to arrive at its net income or net loss.
Note that cost of goods sold is applicable to businesses that sell products. Service businesses will rarely, if ever, have cost of goods sold because they’re providing a service rather than selling goods.