Cost of goods sold for Etsy and handmade sellers
Materials you bought this year are not all an expense this year. Only what went into items you sold is.
What cost of goods sold is
Cost of goods sold (COGS) is the direct cost of the products you sold during the year: materials and parts that became the items, plus purchased items you resold. It is subtracted from gross sales before your other expenses and appears in Part III of Schedule C, which flows to line 4.
The formula
Beginning inventory (January 1)
+ purchases of materials and items for resale
+ cost of labor (wages paid to others to make products, not your own time)
+ other direct costs
− ending inventory (December 31)
= cost of goods sold
What to include
- Raw materials: yarn, wood, beads, fabric, clay, wax, ink, blank shirts.
- Components that become part of the product: clasps, wicks, jars, labels on the product.
- Items bought to resell, plus freight to get them to you.
- Packaging that is part of the product, like a candle tin.
What usually goes elsewhere
- Tools and equipment (a sewing machine, a kiln): depreciation or, under the de minimis rule, an expense.
- Shipping labels to customers: a shipping or supplies expense, not COGS.
- Etsy fees, ads and subscriptions: their own expense lines.
- Your own time: not deductible as labor.
A worked example
Made-up numbers, candle shop
Beginning inventory: 600 (wax, wicks, tins and 40 finished candles at cost)
Purchases in the year: 4,200
Ending inventory: 900 (counted on December 31, at cost)
COGS: 600 + 4,200 − 900 = 3,900
Gross sales 14,500 − COGS 3,900 = gross profit 10,600
If the seller had deducted all 4,200 of purchases, the year's profit would have been 300 too low, and next year's 300 too high. Ending inventory is what moves cost to the year the products actually sell.
Counting inventory
On December 31 (or the closest day you can), count materials on hand and finished items, and value them at what they cost you, not at retail price. A simple sheet with item, quantity and unit cost is enough for most small shops. That number is your ending inventory this year and your beginning inventory next year.
Small business options
Small businesses that meet the IRS gross receipts test have simpler inventory options, such as treating inventory as non-incidental materials and supplies or following the method used in their books. The rules have details worth reading before you choose; the IRS publication for small businesses (Pub. 334) and the Schedule C instructions explain them, or ask a tax professional.
Cost per item helps pricing too
Once you know the material cost of each product, you can check that your price covers it plus fees and your time. A candle with 4.10 of materials, sold at 22 with about 2.50 of fees, leaves 15.40 before labels and your time. The free Etsy fee calculator does the fee part. For the rest of the books, see the Etsy bookkeeping spreadsheet guide, and for physical stock levels the inventory spreadsheet guide.
Frequently asked questions
How do I calculate cost of goods sold for a handmade business?
Beginning inventory plus purchases of materials and items for resale, plus labor paid to others and other direct costs, minus ending inventory counted at cost on December 31.
Are shipping labels part of cost of goods sold?
Shipping to customers is usually recorded as a separate expense, not COGS. Freight to bring materials or items for resale to you is part of their cost.
Do I need to count inventory at the end of the year?
Yes, if you use the standard inventory method. Count materials and finished items on hand and value them at what they cost you, not at retail price.
General information, not financial, tax or legal advice. Examples use made-up numbers.
Handmade & Reseller Bookkeeping 2027
Fees, payouts, cost of goods and inventory across Etsy and your other channels, mapped to Schedule C.