The short answer is to keep them separate. Product costs and service costs behave differently, carry different margins, and tell you different things about your business. When they’re lumped into one COGS line on your profit and loss statement, you lose the ability to see which side of the business is actually making money.

For products, COGS includes what you pay to acquire or produce the items you sell. That means the purchase price of inventory, inbound shipping and freight, packaging materials, and any direct labor involved in manufacturing or assembly. If you’re reselling products, it comes down to what you paid for the item plus what it cost to get it to your door.

For services, COGS (sometimes called cost of services or cost of revenue) covers the direct costs of delivering that service. Think direct labor hours for the people doing the work, subcontractor fees, and any materials consumed during service delivery. It does not include rent, software subscriptions, or your phone bill. Those are overhead expenses that you’d pay whether or not you made a sale that month.

In QuickBooks Online, you can create sub-accounts under Cost of Goods Sold to keep things organized. A simple structure works well. One group for product costs like materials, inventory purchases, and freight. Another group for service costs like direct labor, subcontractors, and job-specific materials. This setup gives you a gross profit margin for each revenue stream instead of one blended number that doesn’t mean much.

A common mistake is ignoring COGS for the service side entirely. Some business owners treat service revenue as if there are no direct costs, which pushes everything below the gross profit line and inflates the margin. Others go the opposite direction and dump indirect costs like rent and utilities into COGS, which deflates margins and makes profitable work look like it’s barely breaking even.

The rule of thumb is simple. If a cost wouldn’t exist without a specific sale or project, it belongs in COGS. If you’d pay it regardless of whether you made a single sale that month, it’s an operating expense.

When both sides of the business share costs, allocate them reasonably. If your warehouse stores inventory but also serves as workspace for service delivery, split the cost based on usage. Don’t overthink it. A reasonable and consistent allocation is more valuable than perfect precision that takes hours every month.

Review your profit and loss statement monthly with the split visible. Over time you’ll notice patterns. Maybe your products carry a 35% margin while services run closer to 60%. That changes how you price things, where you invest, and what you promote. A QuickBooks ProAdvisor in Long Beach can help you set up this structure correctly from the start so the reports actually give you useful information instead of a single number that hides the real story.