What is Cost of Revenue?

Cost of Revenue

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Cost of Revenue

Cost of revenue, also known as cost of goods sold (COGS) or cost of sales, refers to the direct costs attributable to the production or procurement of the goods or services a company sells. These costs are subtracted from a company’s revenue to determine its gross profit.

For a manufacturing company, the cost of revenue might include:

  • Direct labor costs (wages for employees directly involved in the production process)
  • Direct materials costs (raw materials used in production)
  • Manufacturing overhead costs that are directly tied to the production process (such as factory utilities)

For a service company, the cost of revenue might include:

  • Wages for employees delivering the service
  • Cost of utilities or rent for the space where the service is delivered

For a retail company, the cost of revenue is typically the cost of the merchandise it resells to consumers.

It’s important to note that the cost of revenue does not include indirect costs, such as marketing expenses, research and development costs, or general administrative expenses. These are considered operating expenses and are deducted further down the income statement when calculating operating profit.

Analyzing the cost of revenue and how it changes over time can provide important insights into a company’s operational efficiency, pricing strategy, and profitability.

Example of Cost of Revenue

Let’s consider a simple example of a small business that makes wooden furniture.

Let’s say in a given month:

  • The company sells 100 tables at $200 each, generating total revenue of $20,000.
  • The raw materials (wood, screws, glue, etc.) to make each table cost $50.
  • The direct labor cost for each table (wages for the carpenters) is $30.

So, the total cost of revenue would be:

Cost of Raw Materials + Cost of Direct Labor
= (100 tables * $50/table) + (100 tables * $30/table)
= $5000 + $3000
= $8000

So, the cost of revenue for the month is $8000.

The gross profit can then be calculated as:

Total Revenue – Cost of Revenue
= $20,000 – $8000
= $12,000

So, the gross profit for the month is $12,000.

This gross profit figure doesn’t take into account other operating expenses the business might have, like rent, utilities, administrative costs, marketing costs, etc. Those would be subtracted from the gross profit to get the operating profit.

By understanding the cost of revenue, the business can look for ways to become more efficient (like negotiating lower prices for raw materials or improving labor productivity) to increase gross profit. It can also inform pricing decisions—if the market would bear a higher price for the tables, that could also increase gross profit.

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