I remember standing in the middle of our warehouse floor during my first real peak season as an operations director. It was mid-November, and we were gearing up for what would eventually be a 5.3x return spike during BFCM. But at that moment, my anxiety wasn't about returns; it was about production. We had pallets of raw materials sitting in one corner and a frighteningly small pile of finished goods in the other. My CFO walked up, holding a P&L statement that looked nothing like the reality on the floor, and asked, "Why are our production costs so high when we haven't shipped anything?" It was a visceral reminder that in the world of physical products, cash gets trapped in strange places between the factory and the customer. If you don't have a handle on the math of production, you aren't running a business; you’re just financing a very expensive hobby.
Why DTC Brands Need to Obsess Over the Cost of Goods Manufactured Formula
If you are just dropshipping, this article might not be for you. But if you are a DTC brand that designs, assembles, or creates unique products—even if you use a contract manufacturer—you need to understand the difference between what you bought and what you actually made.
Many founders conflate "Cost of Goods Sold" (COGS) with "Cost of Goods Manufactured" (COGM). They are cousins, but they are definitely not twins. COGS is what you expense when a sale happens. COGM is the total value of the inventory you finished creating during a period, regardless of whether it sold.
Here’s where ops breaks: When you rely solely on a basic COGS number from your e-commerce platform, you miss the nuance of your production efficiency. You might think your product costs $10 to make because that's what the raw materials cost. But when you factor in the labor to assemble it, the rent for the facility it was assembled in, and the electricity used by the machines, the real cost might be $18. If you're pricing based on $10, you're bleeding margin and don't even know it.
Understanding what is the formula for cost of goods manufactured allows you to see where your cash is tied up. Is it stuck in raw materials? Is it sitting half-finished on an assembly line (Work in Process)? Or is it sitting as finished inventory waiting for an order? Knowing this is the difference between liquidity and a cash crunch.
The Three Pillars: The Ingredients of the Formula
Before we get to the final equation, we need to break down the three critical components that feed into the total manufacturing cost formula. If your data for these three inputs is messy, your final calculation will be useless garbage.
1. Direct Materials
This is the easiest part to understand but often the hardest to track accurately. Direct materials are the raw inputs that physically become part of the finished product. If you sell high-end leather jackets, this is the leather, the zippers, and the lining.
Where brands mess this up is failing to account for scrap and spoilage. If you buy 100 yards of fabric but waste 10 yards due to inefficient cutting patterns, the cost of that waste needs to be factored into the 90 yards that actually made it into finished goods. You need robust inventory tracking—whether in NetSuite or a specialized ERP—to know exactly what raw materials were consumed, not just what was purchased.
2. Direct Labor
This is the cost of the humans who physically touch the product to make it. It includes the wages, benefits, and payroll taxes of the assembly line workers, the machine operators, or the artisans crafting the goods.
It does not include the salary of the warehouse manager supervising them, nor does it include the janitorial staff cleaning the facility. Those are indirect costs. I’ve seen honest failure cases where brands inflated their direct labor by including salaries that should have been overhead, making their per-unit economics look terrible and leading to unnecessary price hikes that hurt conversion.
3. Manufacturing Overhead
This is the silent killer. This is the bucket for all the indirect costs associated with running your production facility. It includes:
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Rent or mortgage on the manufacturing space (not the corporate office).
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Utilities (electricity, water) for the factory.
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Depreciation on machinery (that expensive CNC machine or industrial loom).
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Indirect labor (supervisors, quality control inspectors, maintenance staff).
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Small, inexpensive materials (like glue or thread) that are too tedious to track individually.
Now the logistics math that matters: You have to allocate this overhead to the products you made. If you paid $50,000 in factory rent this month and produced 10,000 units, that's $5 of rent overhead baked into every single unit.
(Parenthetically, I’ve always found that underestimating manufacturing overhead is the single most common reason early-stage hardware startups run out of cash before they hit scale).
The Work in Process (WIP) Trap
Before we can finally answer how to calculate cost of goods manufactured formula, we have to deal with the most confusing element: Work in Process (WIP).
WIP represents goods that have started the production cycle but aren't finished yet. At the beginning of the month, you have "Beginning WIP"—the stuff leftover from last month. During the month, you add new materials, labor, and overhead. At the end of the month, you have "Ending WIP"—the stuff that still isn't done.
You need to know the value of what's sitting half-done on the floor. This is notoriously difficult to estimate. How much labor has gone into a half-assembled bicycle? I recall a warehouse backlog situation where we had hundreds of units sitting in a "quasi-finished" state waiting for a single delayed component from overseas. Valuing that pile for the monthly close was an accounting nightmare that delayed our financial reporting by two weeks.
The Big Reveal: The Cost of Goods Manufactured Formula
Okay, let’s put it all together. To figure out how to find cost of goods manufactured, you need to follow a specific flow. It's often presented as a "schedule" by accountants.
Here is the step-by-step logic for the cost of goods manufactured calculation formula:
Step 1: Calculate Direct Materials Used
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Beginning Raw Materials Inventory
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+ Purchases of Raw Materials
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= Raw Materials Available for Use
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- Ending Raw Materials Inventory
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= Direct Materials Used
Step 2: Calculate Total Manufacturing Costs
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Direct Materials Used (from Step 1)
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+ Direct Labor
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+ Manufacturing Overhead
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= Total Manufacturing Costs Incurred
Step 3: Calculate Cost of Goods Manufactured (COGM)
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Total Manufacturing Costs Incurred (from Step 2)
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+ Beginning Work in Process (WIP) Inventory
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- Ending Work in Process (WIP) Inventory
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= Cost of Goods Manufactured
Therefore, the consolidated formula is:
This final number—the COGM—is the total value of the products that were completed and moved into finished goods inventory during the period.
The "Schedule of Cost of Goods Manufactured"
When accountants talk about the schedule of cost of goods manufactured, they are referring to the formal report that lays out the math above. It’s an internal document, not usually shown to the public, but it feeds directly into your Income Statement to calculate the Cost of Goods Sold.
Why go through all this trouble? Because it forces you to reconcile your physical reality with your financial reality. If your schedule shows you used $100k in raw materials, but your warehouse manager says the raw materials racking is still full, you have a massive data disconnect that needs to be solved immediately.
The Hidden Variable: How Returns Wreck Your Calculations
Now, here’s where ops breaks in the modern DTC environment. The traditional cost of goods manufactured formulaassumes a linear path: raw materials in, finished goods out, customer keeps product.
But what happens when 30% of those finished goods come back?
When a product is returned, it re-enters your ecosystem. But at what value? It’s no longer a "new" finished good. It might need refurbishment, repackaging, or it might be scrap.
I worked with a brand that was seeing a painful reality: it cost them $27 in end-to-end processing to handle a return for an item with a resale value of only $19. They were spending money on shipping labels (via platforms like Loop), labor at a central warehouse to inspect it, and repackaging materials, only to sell it at a discount.
If your manufacturing team is busting their backs to shave cents off the COGM, but your returns process is bleeding dollars, you are fighting a losing battle.
How Closo Solves Returns and Protects Your Margin
This is where a decentralized approach to returns becomes critical for protecting the margins you worked so hard to build during manufacturing. How Closo solves returns is by intercepting these items locally.
Instead of shipping a return across the country to a central hub—incurring high shipping costs and clogging up your primary facility—Closo routes it to a local hub.
We route eligible returns locally instead of sending everything back to the warehouse — cutting return cost from ~$35 to ~$5 and speeding refunds.
By processing returns locally and quickly, you get faster visibility into what inventory is actually salvageable. This allows you to make smarter decisions about future manufacturing runs. If you know you have 500 units of "Grade A" refurbished inventory sitting in local hubs ready for resale, you don't need to manufacture 500 new units. This keeps your production lean and your cash freed up. For more on how this decentralized model works, check out our detailed breakdown of return hubs.
Bridging Manufacturing and Demand: The AI Advantage
The ultimate goal of understanding the formula for cost of goods manufactured isn't just to report the past; it's to plan the future. You want to manufacture exactly what you can sell, minimizing storage costs at 3PLs like ShipBob and avoiding clearance sales.
(I’m still uncertain why so many brands treat manufacturing and demand planning as separate silos—they are inextricably linked).
Over-manufacturing is a massive drain on resources. I recall an honest failure case where a brand, buoyed by a few good months, doubled their production order. The trend died, and they were left holding six months of inventory that slowly depreciated in a warehouse. Their COGM was efficient per unit, but their total cash outlay was disastrous.
How Closo predicts demand with Google Trends & the AI helps bridge this gap. By analyzing search interest and combining it with real-time return data (knowing what's coming back into stock), brands can forecast their manufacturing needs with much higher accuracy.
Instead of relying on gut feelings or outdated spreadsheets, you can use AI-driven insights to determine if that spike in demand is a sustainable trend or a flash in the pan. This ensures that the capital you pour into your cost of goods manufactured actually converts into profitable sales. You can learn more about bridging these operational gaps in our main brand hub
Conclusion
Mastering the cost of goods manufactured formula is tough. It requires disciplined data tracking across raw materials, labor, and the murky world of overhead. But for a DTC operator, it is non-negotiable. It is the only way to understand the true efficiency of your production engine.
However, knowing your manufacturing costs is only half the battle in 2026. You must also control the costs of your reverse supply chain. If you build it efficiently but process its return inefficiently, your P&L will still bleed.
The winning brands of the next decade will be those that connect the dots between efficient manufacturing, AI-driven demand planning, and localized, cost-effective returns. It’s time to stop looking at these as separate departments and start treating them as one integrated profit machine.
We route eligible returns locally instead of sending everything back to the warehouse — cutting return cost from ~$35 to ~$5 and speeding refunds. If you're ready to protect the margins you work so hard to create, let's talk about optimizing your entire product lifecycle.
Operators always ask me... (FAQ)
Common question I see: Is Cost of Goods Manufactured the same as Cost of Goods Sold?
No. Cost of Goods Manufactured (COGM) is the total cost of the products completed during a period. Cost of Goods Sold (COGS) is the cost of the products actually sold during that period. You use COGM to calculate COGS: Beginning Finished Goods + COGM - Ending Finished Goods = COGS.
What if my manufacturing overhead fluctuates wildly month-to-month?
This is common. I recommend using a "predetermined overhead rate" based on annual estimates to smooth out monthly variances, and then reconciling the difference at the end of the year. Otherwise, your unit costs will look wildly different in January (high heating bills) versus July.
Do I need this formula if I use a contract manufacturer?
Yes, but it's simpler. Your "Direct Materials" and "Direct Labor" are essentially wrapped up in the purchase price paid to the manufacturer. However, you still need to account for any materials you supply them, plus your own internal overhead related to managing that production (freight in, customs duties, QA team salaries).
