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Cost of revenue is one of the major components of an income statement. Learning about the details of the same helps business owners to ascertain the direct costs related to the goods and services offered by the company. In turn, it helps in profit calculation and allows business owners to optimise the same successfully.

What is Cost of Revenue?

It can be defined as the cost of manufacturing, production and distribution of goods and services of a company to consumers. Notably, as a concept, it is more than the cost of products sold and tends to include certain activities associated with a sale.

Types of Cost of Revenue

The types of cost of revenue from operations typically depend on the company.

Here are the most prominent types –

a) From a product-oriented company

  • Direct material
  • Direct expenses
  • Direct labour
  • Marketing cost
  • Distribution cost
  • Other expenses related to production and distribution

b) From a service-oriented company

It must be noted that a service-oriented firm does not incur any material expenses. Typically, its costs are concerned with the labour force. With that being said, the following are the most prominent cost of revenue examples in a service-oriented company.

  • Direct labour
  • Direct expenses
  • Marketing costs
  • Other expenses related to production and distribution

Nonetheless, to compute the cost of revenue from operations, one must also become familiar with the exclusions. Typically, indirect expenses, administrative costs and research and development costs are not included in the computation.

Cost of Revenue Calculation Example

Before taking a quick look at the calculation of the cost of revenue examples, one must keep these following pointers in mind.

  • Usually, the cost is computed over a quarter or a year.
  • The factors accounted for to achieve accurate value include opening inventory value, cost of goods manufactured and sold and closing inventory value. Notably, all expenses associated with production and sales must be accounted for.
  • Subsequently, the production cost should be added to the inventory’s initial value. The total must be subtracted from the inventory’s closing value for the given period to avail the accurate cost of revenue.
  • In the service industry, companies do not incur any production cost, and sometimes there is no inventory involved. In such a situation, one can factor in the direct cost involved with sales to ascertain the cost of revenue of a firm.

Example: Suppose, the revenue of a firm for the year 2018-2019 is Rs.20,00,000, direct material is Rs.380,000, labour cost is Rs.250,000 and research and development cost is Rs.350,000. Also, freight and handling charge is Rs.36,000; indirect expenses amount to Rs.123,000, direct cost is Rs.17,500 and admin charge is Rs.200,000.

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So, the cost of revenue is –

= Direct material + direct labour + direct costs + freight and handling charges

= Rs.(380000 + 250000 + 175000 + 36000)

= Rs.841000

One can also compute the cost revenue ratio of a firm by taking a quick look at its income statement. Typically, such a ratio is calculated by dividing cost by revenue and is expressed as –

Cost revenue ratio = Cost / Revenue

At any given time, a lower cost revenue ratio indicates more proficiency than a higher ratio.

Significance of Cost of Revenue 

It proves useful in more than one way. These following pointers highlight its significance.

  • Calculation of direct cost

By calculating the cost of revenue, one can also ascertain the direct costs involved with a firm’s production and distribution.

  • Ascertaining gross profit of a firm 

One can easily compute the gross profit of a firm with the help of its cost of revenue. To elaborate, by simply subtracting the cost of revenue from total revenue, one can ascertain the gross profit of a firm.

  • Facilitates decision making

Cost of revenue helps to identify all the direct and indirect costs of production of a firm. In turn, it aids business owners to identify excess expenses and adjust them accordingly.

Cost of Revenue versus Cost of Goods Sold

Usually, the term cost of goods sold and cost of revenue are used interchangeably. However, there is one fundamental difference between the two which sets them apart from one another.

To elaborate, the expense related to marketing and distribution is not factored in for the cost of goods sold. Notably, the primary difference tends to lay in their usage.

For instance, manufacturers are more likely to factor in COGS and on the other hand retailers of service-oriented business are more likely to account for the cost of revenue. It is because they cannot record the intangible items on their income statements or relate the same with operating expenses.

Bearing these in mind, business owners must utilise this crucial component in their favour. In turn, they will be able to account for the operational cost better and subsequently improve upon their efficiency significantly.

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