The cost of revenue is the net cost of the products or services provided by the company, excluding secondary costs such as research and development-related expenses. The cost of revenue includes all expenses necessary to produce basic products or services.
Explanation:
The cost of revenue is one of the principal concepts in economics and accounting practices. It is limited to the expenses of the company that are directly related to the goods or services. In other words, it is the services provision expenses or the cost of manufacturing, production, and distribution of the products that bring the primary income of the company. Thus, the components of the cost of revenue for a service company and a product-oriented one differ.
In the first case, the expenses on revenue may include payment for human labor, which is the salaries of the company’s employees, who provide relevant services. They may also cover the cost of necessary materials, equipment, and other items. Direct revenue costs also include a promotion, marketing, and advertising, as service companies often require these.
As for the product companies, the cost of revenue will consist of the purchase of the original material, details, components, and similar items that are used to manufacture the goods. This also includes the salaries of the personnel needed to produce the goods and to organize the work process.
If materials have to be transported from a specific geographic location or if finished goods have to be delivered to the customer, this is also considered a cost of revenue. This may also include a promotion, marketing, product design, and other expenses. The basic criterion for the recognition of certain expenses as revenue costs is their direct attribution to the creation of goods or services through which the company makes a profit.
In addition to revenue costs, the company may have operating expenses. They include all costs that do not meet the criterion mentioned above. These are primarily the costs of employment of financiers, lawyers, and managers, which are not directly related to the production of the product and services, but the effectiveness of the company. It is also the cost of development and research conducted by the company to improve its performance.
The definition of the cost of revenue is necessary to apply the formula used to calculate the company’s gross profit. This formula is: P(x) = R(x) – C(x), where P(x) is a company’s profit, R(x) is a total revenue, and C(x) is a cost of revenue. Total revenue includes all income earned by the company in a particular financial period. When deducted from that revenue, gross profit is generated. When the cost of revenue is deducted from it, net profit is calculated.
Consideration should be given to corresponding examples of large multinational corporations such as Apple Inc. and Alphabet Inc. (created through a corporate restructuring of Google). Apple’s income statement for 2018 contains information that total revenue was 265,595,000, and the cost of revenue was 163,756,000. Inserting these data into the formula above will make it possible to calculate the gross profit of the Apple for 2018, which amounted to 101,839,000.
The same applies to the Alphabet’s income statement for 2018: total revenue (136,819,000) – cost of revenue (59,549,000) = gross profit (77,270,000). Furthermore, it is noteworthy that these income statements contain data on Apple’s and Alphabet’s operating expenses.
They are divided into “research development” and “selling general and administrative” and together total about 30,941,000 for Apple and 45,878,000 for Google. Thus, it is demonstrated that, in both cases, considerably more funds were spent on the revenue costs than on operating expenses.