Cost of goods sold, explained for people who make things

Updated September 14, 2026 · 6 min read · Sources checked on publication

At some point an accountant asks for your cost of goods sold, and the natural answer — “I spent about $4,000 on materials” — is the wrong one. Cost of goods sold is what went into the things you sold, which is a different number from what you bought, and the gap between them is inventory.

The distinction that trips everyone up

You bought ten kilos of wax in November. By 31 December you’ve used six. The other four are sitting in your workshop.

• The six kilos you used — in items you sold — are cost of goods sold. They reduce this year’s taxable profit.
• The four kilos still on the shelf are inventory. They’re an asset you still hold, and they become cost of goods sold in whatever year they’re finally sold inside something.

Which is why the usual shortcut — totalling your material receipts for the year — overstates your costs in a year you stocked up and understates them in a year you ran your stock down. Over a long enough period it evens out; in any single tax year it doesn’t.

What usually belongs in it

• Materials and components physically in the items you sold.
• Packaging consumed by those sales — the box, the tissue, the tape.
• Freight you paid to get materials to you, which properly belongs in their cost.
• Waste and failed pieces attributable to production.

What usually doesn’t

• Materials still on the shelf at year end — inventory, not cost.
• Equipment and tools, which are usually treated differently as assets.
• Etsy’s fees and advertising, which are business expenses but typically recorded as commissions, fees and advertising rather than cost of goods sold.
• Your own time. Which brings us to the genuinely confusing part.

Why your labor is in one calculation and not the other

This is the thing that makes handmade bookkeeping feel contradictory, so it’s worth stating directly.

• For the tax return: if you’re a sole proprietor, you generally can’t deduct your own labor as a cost. You’re not an employee being paid a wage; you take the profit. So your hours typically don’t appear in cost of goods sold.
• For pricing and product decisions: your time is unambiguously a cost, and leaving it out is the single most common reason a shop looks profitable and isn’t.

Both are right, for different questions. The tax figure answers “what do I owe?”. The management figure answers “is this product worth making?”. Sellers get into trouble by adopting the tax definition for both, concluding their margins are excellent, and wondering where the money went — paying yourself covers the other side.

The stocktake nobody wants to do

Splitting used from unused requires knowing what’s on the shelf at year end. For a small shop that’s an afternoon with a notebook: count the significant materials, value them at what you paid, and write it down with the date.

Do it on the same date each year and the comparison does most of the work — the change in inventory between two year ends, combined with what you bought, gives what you consumed without tracking every gram.

For most handmade shops, materials on hand are modest enough that precision isn’t the point. Consistency is. A rough count done the same way every year is far more useful than an exact one done once.

Why this is worth getting right beyond the tax return

The same figures that produce cost of goods sold produce your per-product margin — the difference being that the management version includes your time and the tax version doesn’t. Keep the underlying data once, in enough detail, and both fall out of it.

That’s what MakerMargin is built around: material costs recorded once per material and referenced by product recipes, so a supplier price rise updates everything, and real Etsy fees from the files Etsy exports. Its year-end summary lays the result out in the categories a Schedule C expects, and tells you which months came from an exact statement and which were estimated.

The wider list of deductible costs is in what’s deductible, and the mechanics of costing materials properly are in costing materials.

This is general information about a widely-used accounting concept, not tax advice, and the treatment of inventory, owner labor and equipment varies by country and business structure. Etsy fee categories referenced are from Etsy’s Fees & Payments Policy, read 14 September 2026. Confirm anything here with a professional before relying on it.