Cost of Revenue: What It Is and How to Calculate It

What it is

Cost of revenue is the total direct cost a company incurs to produce and deliver its goods or services to customers. It appears on the income statement and aims to capture the expenses directly tied to generating sales, beyond just production costs. Service companies often prefer this metric because it can include a broader set of direct selling and delivery costs.

Key takeaways

• Cost of revenue measures all direct costs required to earn revenue, not just manufacturing.
• It includes COGS plus other direct expenses such as shipping, commissions, returns and warranties.
• It is useful for calculating a more complete gross profit related to sales.
• Cost of revenue is not a GAAP-defined single line item and may be calculated differently across companies.

How it works and formula

Cost of revenue = COGS + Shipping + Commissions + Warranties + Returns + Other direct costs

Steps to calculate:
1. Choose the reporting period (monthly, quarterly, annually).
2. Determine beginning/ending inventory to calculate COGS if applicable.
3. Sum all direct costs that are directly attributable to producing and delivering the product or service for that period.
4. Monitor the “other direct costs” category; it varies by company and can change over time.

What is typically included

Common components (may vary by company):
* Direct materials — raw materials and associated acquisition freight/handling.
* Direct labor — wages and benefits for employees directly producing or delivering goods/services.
* Manufacturing overhead — production-related utilities, equipment maintenance when directly tied to production.
* Freight and shipping — costs to deliver finished goods to customers or retailers.
* Duties and taxes — import/export duties necessary for distribution.
* Returns and warranties — expected returns, restocking costs, and warranty service costs.
* Commissions — payments to sales agents, distributors, or intermediaries tied to sales.
* Other direct costs — industry- or product-specific direct expenses.

Note: Some items (e.g., management salaries, rent not directly tied to production) are indirect and typically reported as operating expenses, not cost of revenue.

Cost of Revenue vs. COGS and Operating Expenses

• Cost of Goods Sold (COGS): Focuses on the direct costs of producing goods (materials, direct labor, manufacturing overhead). Cost of revenue includes COGS plus additional direct selling/distribution costs.
• Operating expenses: Indirect costs not tied directly to producing or delivering a product (e.g., administrative salaries, general marketing, rent). These remain separate from cost of revenue.
• Contribution/gross margin implications: Including extra direct selling and delivery costs in cost of revenue produces a lower gross profit than a margin based only on COGS.

Example

Company XYZ:
* Total revenue: $100 million
COGS: $15 million
Cost of services sold: $7 million
Direct labor (production/delivery): $5 million
Marketing directly tied to sales: $1 million
* Direct overhead: $3 million
(Exclude indirect management compensation and rental costs.)

Cost of revenue = 15 + 7 + 5 + 1 + 3 = $31 million
Gross profit (revenue − cost of revenue) = $100M − $31M = $69 million
Cost of revenue as a percentage of revenue = 31%

Why it matters

Understanding cost of revenue helps managers and investors see the full direct cost of generating sales, allowing better pricing, margin analysis, capital allocation, and operational decisions. It gives a clearer view of the true profit contribution of products or services than COGS alone.

Common questions

Q: Is cost of revenue an expense?
A: Yes. It represents the direct expenses incurred to generate revenue. Some elements (returns, warranties) may be recorded as contra-revenue accounts.

Q: Is cost of revenue standardized?
A: No. It is not a GAAP-prescribed single-line item and companies may define and report it differently.

Q: When should a company use cost of revenue?
A: It’s especially useful for service firms or businesses with significant direct selling/distribution costs, or when you want a fuller picture of direct costs tied to revenue generation.

Bottom line

Cost of revenue aggregates all direct costs required to produce and deliver goods or services, combining COGS with additional direct selling and distribution expenses. Because its composition varies by company, it should be interpreted in context and used alongside other financial metrics to assess profitability.