What is Cost of Goods Sold?
Cost of Goods Sold (COGS) is the direct cost of producing or acquiring the goods a business sells during a specific period, including raw materials, direct labor, and manufacturing overhead. According to the SBA, COGS is one of the primary line items lenders examine on a business’s income statement, with most product-based small businesses carrying COGS ratios between 30% and 70% of gross revenue.
How Cost of Goods Sold Works in Business Lending
Lenders use Cost of Goods Sold to assess your business’s operational efficiency and profitability before approving a loan. COGS is subtracted from total revenue to calculate gross profit, which in turn drives gross profit margin — a ratio lenders scrutinize closely. A strong gross profit margin (typically above 40% for product-based businesses and above 60% for service-based businesses) signals that your business retains enough revenue to cover operating expenses, debt service, and growth. The SBA’s underwriting guidelines require lenders to evaluate a borrower’s Debt Service Coverage Ratio (DSCR), which depends directly on net income — a figure that cannot be accurately assessed without a clear understanding of COGS. Lenders will typically review two to three years of income statements to spot rising or inconsistent COGS trends, which may indicate supply chain issues, pricing problems, or poor inventory management.
Different lenders weight COGS analysis differently depending on the loan product. SBA 7(a) lenders and SBA 504 lenders follow federal underwriting guidelines that require detailed income statement review, meaning COGS is formally documented and scrutinized in the approval process. Traditional community banks and credit unions also rely heavily on COGS trends when evaluating term loans and lines of credit, often requiring a minimum gross margin to qualify. Online lenders and alternative financing platforms may apply more flexible standards, sometimes focusing on revenue volume rather than margin, making them a viable option for businesses with temporarily elevated COGS. CDFIs (Community Development Financial Institutions) may work with businesses in industries where COGS is historically high — such as food service or manufacturing — by considering contextual factors alongside the raw numbers.
What Business Owners Should Do About Cost of Goods Sold
To present the strongest possible lending profile, business owners should actively manage and document their Cost of Goods Sold before applying for a loan. Start by ensuring your bookkeeping clearly separates COGS from operating expenses — a common accounting error that distorts your gross margin and raises red flags with underwriters. Review supplier contracts annually and seek volume discounts or alternative vendors to reduce direct material costs. If your COGS has spiked recently due to supply chain disruptions or inflation, prepare a written explanation with supporting data to accompany your loan application — lenders respond well to transparency paired with a concrete plan. Timing matters too: apply for financing during a quarter when your COGS ratio is stable or improving, as lenders often weight the most recent 12 months of data most heavily. Organize at least two years of profit and loss statements, your most recent tax returns, and any inventory valuation reports before approaching a lender.
Understanding your Cost of Goods Sold is only the first step — finding the right lender for your specific margin profile is just as important. We connect you with lenders — we do not lend — which means our role is to match your financial picture, including your COGS ratios and gross margin trends, with the SBA lenders, community banks, CDFIs, and online lenders most likely to approve your application under favorable terms. This saves you time and protects your credit from unnecessary hard inquiries.
What Cost of Goods Sold ratio do lenders require for a business loan?
There is no universal COGS threshold, but lenders generally look for a gross profit margin of at least 25% to 30% for product-based businesses, which implies a COGS ratio no higher than 70% to 75% of revenue. SBA lenders require a DSCR of at least 1.25, meaning your business must generate USD 1.25 in net income for every USD 1.00 in debt obligations — a benchmark that tightens as COGS climbs. Community banks may require gross margins above 40% for unsecured term loans, while online lenders may approve businesses with thinner margins if monthly revenue exceeds USD 10,000.
How does Cost of Goods Sold affect my interest rate?
A lower COGS ratio produces a higher gross profit margin, which signals lower operational risk and typically qualifies your business for more competitive interest rates. Per the Federal Reserve’s 2023 Small Business Credit Survey, businesses with stronger profitability metrics — directly influenced by COGS efficiency — were significantly more likely to receive full loan approval and better pricing from institutional lenders. Improving your gross margin from 30% to 50% by reducing COGS could meaningfully lower your perceived risk profile and reduce your APR by 2 to 5 percentage points depending on the lender and loan type.
Can I get a business loan with poor Cost of Goods Sold performance?
Yes, financing options exist even when your COGS is high or your margins are thin, though traditional bank loans and SBA products will be harder to qualify for without a remediation plan. Merchant Cash Advances (MCAs) from online lenders prioritize daily revenue volume over margin, making them accessible to high-COGS businesses — though they carry higher effective APRs. CDFIs and nonprofit lenders, including those backed by SBA microloan intermediaries, often serve businesses in margin-challenged industries and may provide capital up to USD 50,000 alongside technical assistance to help improve your cost structure.
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Sources: SBA.gov, Federal Reserve 2023 Small Business Credit Survey, CFPB, FDIC. Small Business Loans Today is an independent affiliate publisher — not a lender or broker.