The term ‘cost of revenue’ refers to the total cost involved in producing and delivering a product or service to consumers. These details are found in a company’s income statement and represent the direct costs associated with the goods and services provided. The service industry often relies on this metric as it offers a more thorough account of various costs involved in selling a product or service.
Key Takeaways
- Cost of revenue encompasses the total cost involved in producing and delivering a product or service to consumers.
- This information is detailed in a company’s income statement.
- The service industry favors using cost of revenue for a comprehensive account of selling costs.
- It differs from the cost of goods sold by including external production costs like distribution and marketing.
- Examples include cost of goods sold, warranties, returns, shipping, and commissions.
How Cost of Revenue Works
Cost of revenue is essentially the total cost incurred to produce and sell a product or service, including expenses such as raw materials, labor, and overheads. This metric is crucial for businesses as it helps determine the true gross profit margin. Companies need to know the residual revenue left after covering all costs of production and sales.
Formula and Calculation
The formula for calculating the cost of revenue is:
Cost of Revenue = COGS + Shipping Costs + Commissions + Warranties + Returns + Other Direct Costs
- Determine the calculation period (monthly or quarterly).
- Note the beginning inventory for accurate COGS determination.
- Identify unique direct costs which might change per period as the production process evolves.
What Is Included in Cost of Revenue?
Direct Materials
Direct materials consist of raw materials used in production, including related shipping or handling costs. These are part of the cost of goods sold.
Direct Labor
Direct labor accounts for wages, salaries, and benefits to employees involved directly in production or service delivery. This is also included in the overall cost of goods sold.
Manufacturing Overhead
Includes non-direct costs crucial to production, such as utilities and equipment maintenance. These are also typically reported as part of the cost of goods sold.
Freight and Shipping
Freight and shipping cover distribution costs, essential for delivering products to customers or retailers, thus included in revenue costs.
Duties and Taxes
These are compulsory charges, especially relevant for international goods distribution, hence included in revenue costs.
Returns and Warranties
Costs from product returns, allowances, and warranty periods, as they are directly related to generating sales revenue.
Commissions
Payments to sales agents or intermediaries, directly tied to product sales, included due to their impact on revenue generation.
Other Direct Costs
Unique direct costs specific to a product line or industry, essential for a complete cost of revenue representation.
Cost of Revenue vs. Cost of Goods Sold
Cost of revenue includes additional costs outside production like distribution and marketing, unlike cost of goods sold which focuses on production costs only. This broader measure results in a lower profit margin value compared to standard formulas used in income statements.
Cost of Revenue Example
Consider XYZ Inc. selling electronics and repair services with a total revenue of $100 million, COGS at $15 million, and cost of services at $7 million. Additional direct labor costs amount to $5 million, marketing $1 million, and overhead costs $3 million. The management costs of $10 million and rental of $8 million are indirect costs and thus excluded. Consequently, the cost of revenue is $31 million for the fiscal period with a revenue margin of 69% and a cost of revenue to total revenue percentage of 31%.
Cost of Revenue vs. Operating Expenses
Operating expenses cover non-manufacturing costs, a broader category with more indirect costs compared to the focused cost of revenue that includes direct and production-related expenses.
Is Cost of Revenue an Expense?
Yes, it’s an aggregate of costs necessary to generate product-specific income. Components might sometimes be reported as contra revenue accounts.
Why Is Cost of Revenue Important?
Understanding cost of revenue allows companies to accurately gauge all costs associated with earning income, enabling more strategic capital deployment.
The Bottom Line
Cost of revenue includes production costs, and also any other necessary costs for delivering or marketing a product. This comprehensive metric helps businesses understand the true profit margin for their products.
Related Terms: Direct Costs, Gross Margin, Net Profit, Operating Expenses, Contribution Margin
