What It Is, How It’s Calculated, Example

What Is Cost of Revenue?

The term cost of revenue refers to the total cost of manufacturing and delivering a product or service to consumers. Cost of revenue information is found in a company’s income statement. It is designed to represent the direct costs associated with the goods and services the company provides. The service industry often favors using the cost of revenue metric because it is a more comprehensive account of the various costs associated with selling a good or service.

Cost of Revenue vs. Cost of Goods Sold

Cost of revenue is different from cost of goods sold (COGS) because the former also includes costs outside of production, such as distribution and marketing. The cost of revenue takes into account the cost of goods sold (COGS) or cost of services provided plus any additional costs incurred to generate a sale.

Although the cost of revenue factors in many costs associated with sales, it does not take into account the indirect costs, such as salaries paid to managers. The costs considered part of the cost of revenue include a multitude of items, such as the cost of laborcommission, materials, and sales discounts.

When comparing profit measures using a standard formula for profit margins such as those listed in an income statement, creating a profit margin measure based on the cost of revenue would generate a lower value than those typically used by corporations for quarterly reporting. That’s because it includes the COGS or cost of services and other direct costs.

The contribution margin includes total variable costs, and the gross margin only includes the COGS or the cost of services. A company with a low cost of revenue to total revenue percentage indicates that it is in stable financial health and may have strong sales.

Cost of Revenue Example

Here’s a hypothetical example of how the concept of cost of revenue works. Let’s assume XYZ Inc. sells electronics products and offers services to repair electronic equipment. The company reports total revenue of $100 million, COGS of $15 million, and cost of services sold of $7 million. The company has direct labor costs of $5 million, marketing expenses of $1 million, and direct overhead costs of $3 million. XYZ also pays $10 million to its management and records rental costs of $8 million.

We can determine from this information that the company’s cost of revenue is $31 million for the fiscal period. The $10 million paid to its management and the rental costs of $8 million are indirect costs, which are not included in the cost of revenue. Since the company had total revenue of $100 million, XYZ Inc. has a cost of revenue margin of $100 million ($31 million = $69 million.) Moreover, the company has a cost of revenue to total revenue percentage of 31%, or $31 million divided by $100 million.