How to calculate cost of revenue
The revenue to cost ratio is one of those metrics that play the biggest role in B2B sales. With its help, businesses can ensure that their sales volumes grow, whereas the cost of operations remains low, stimulating revenue growth. Basically, this ratio is the key to business success; thus, every company needs to know how to calculate the cost of revenue.
From its name, it is not hard to guess that the revenue and cost ratio formula consists of just two variables - total revenue and total cost. Yet, it’s crucial to know how to calculate each variable accurately and measure them against each other.
So, here is a brief guide on how to calculate CRR step by step.
1) Define the cost of revenue
In order to find your total variable costs, you need to keep in mind all manufacturing expenses. For this purpose, you can use different financial statements that your company has, for example, a balance sheet. You want to consider the following:
- Labor costs;
- Marketing costs;
- Material costs;
- Distribution costs;
- Administrative expenses;
- Overhead costs, etc.
Once you have all the costs, use a simple cost of revenue formula - add up all direct costs your business has and move on to the next stage.
2) Define the total revenue
Now that you have a revenue cost formula in mind, you need to define your revenue. First of all, you need to know what it stands for.
Total revenue is basically the gross revenue of your business. Simply put, it is the total amount of money generated by your business before deducting any costs incurred, such as manufacturing or marketing expenses, corporate tax liabilities, property taxes, etc.
Now, how do you calculate revenue?
First of all, you have to calculate revenue from sales. To do this, you have to multiply the number of sold units by the cost of every unit. The easiest way to do this is using a financial statement like a balance sheet.
Apart from sales revenue, you also have to calculate additional, non-operating income, for example, dividends or interest.
Once you have a fixed number indicating your sales and non-operating income, add them. Now, you know how to calculate total revenue from the balance sheet.
3) Calculate your sales expense to revenue ratio
When you have all the variables, you can finally calculate the expense ratio to your revenue. Doing this is quite easy. Basically, the revenue and cost ratio is calculated bycost divided by revenue.
The formula looks like this:
Cost of revenue / total revenue = CRR
Typically, the number you will get will be a decimal (smaller than one). That’s why, after you calculate CRR, there will be one more step you need to take.
4) Calculate the percentage
As was already mentioned, the answer you will get using the formula above will be a decimal. Due to this reason, financial professionals typically use percentages when it comes to calculating CRR. So, the last step you need to take is to calculate the rate of the CRR you’ve already found.
Doing this is simple – just take the figure you received using the CRR formula and multiply it by 100.
Cost of revenue vs. COGS
Speaking about various business-related expenses, financial specialists use different cost categories to measure and compare the company’s expenses. Primarily, the two most important cost categories for calculating efficiency ratios are the cost of revenue and the cost of goods sold (COGS).
We have to admit that the cost of revenue and cost of goods sold ratio are very similar. So, there is often a lot of misunderstanding between these two cost groups. But, in fact, they are not the same.
Let’s take a moment to consider the cost of revenue vs. COGS to find the differences.
Cost of goods sold
What are COGS? According to the general cost of goods sold definition, it is a direct cost of producing goods.
To calculate the cost of sales percentage, specialists add up two primary expenditures:
- Cost of labor;
- Cost of materials.
Cost of revenue
The cost of revenue is much different. It represents the total cost of manufacturing, marketing, and delivering goods to customers. Thus, apart from the cost of labor and materials, the cost of revenue also involves additional fixed costs like overhead, shipping, and distribution expenses. It also involves additional variable costs, such as the cost of every marketing campaign and marketing materials.
Who works with these indicators? If you are hoping to improve your indicators, chances are that you will want to find the right specialists to handle this task. To help you get on the right track, here is a list of the top job opportunities that imply working with cost-revenue ratios:
- Financial advisor;
- Financial analyst;
- Budget analyst;
- Market research analyst;
People with such titles often have to deal with CRR and possess the needed skills and knowledge.
Cost of revenue vs. cost of sales
We’ve already looked at the cost of revenue vs. cogs. Now, what is the cost of sales? Instead of giving you a lengthy and complicated cost of sales definition, let’s make it clear straight away. There are many names for this indicator. Financial specialists call it COGS, the cost of goods sold, and also the cost of sales. So, if you ever wonder, “is cost of sales the same as cost of goods sold,” the answer is yes.
Just like the COGS ratio, the cost of sales is calculated based on the labor and material costs used to produce a particular product. The cost of revenue, on the other hand, involves labor and material costs plus additional expenses, such as rent, taxes, design and maintenance of corporate websites, lead generation, marketing, etc. Thus, unlike the cost of sales or COGS, the cost of revenue gives a more comprehensive outlook on the expenses borne by the company.
Cost and revenue in B2B lead generation
Now that you know about the huge role of the expense to revenue ratio in the business, chances are that you are also wondering where this metric is applied.
Despite a common belief, the cost to charge ratio formula is used not only to manage the company’s financial operations but can also be applicable to its sales and lead generation efforts. Businesses that focus on lead generation and e-commerce don’t want to leave space for guesswork when it comes to their profits. They want their sales goals to align with their budgets. And that’s where the cost to profit ratio plays a massive role.
By approximating the cost vs. revenue, businesses can obtain a benchmark for selling their products or services. Simply put, they receive a forecast of how much profit they can get from generating or buying leads and can adjust their budgets and goals accordingly.
Belkins offers you plenty of benefits here. With our unique B2B lead generation techniques, your business can streamline sales and align costs and revenues to its goals and budgets.
Calculation examples and cost and revenue calculator
If you want to grasp all operational expenses, you need to calculate your CRR. As you already know, the formula for calculating CRR looks like this:
Cost of revenue / total revenue = Cost revenue ratio
We have learned that the results are typically given in percentages, so the complete formula also includes multiplying the obtained result by 100%.
Let’s say your direct cost is $5M, and your total revenue is $7.5M. Using the formula, you calculate CRR like this:
5,000,000 / 7,500,000 = 0,666…
Now, round this number to decimals and multiply it by 100:
0.67 x 100 = 67%
In this example, your cost-revenue ratio is 67%, where percentages indicate how much each cost generates per $100. Respectively, for every $67 you spend, you generate $100 in revenue.
If you are wondering how to calculate fees earned against manufacturing expenses (labor + materials), you need to calculate the cost-to-sales ratio. The sales cost to income ratio is calculated similarly. But, instead of dividing the total cost of revenue by the total revenue, you have to split the cost of sales by the total revenue. Here is what the COGS revenue ratio formula looks like:
Cost of sales (COGS) / total revenue = Cost to sales ratio
This metric is also provided in percentages, so you will need to multiply the result by 100 too.
For example, if your cost of sales is $600K and your total revenue is $7.5M. Using the formula, you calculate CSR like this:
600,000 / 7,500,000 = 0.08
Now, multiply this by 100, and you will discover that your cost to sales ratio is 8%.
As you can see, the formulas are elementary, so it won’t take a lot of time to calculate your performance indicators. Nevertheless, there is an easier way to do this. These days, businesses can leverage online calculators to simplify complex calculations. There are many different tools, including a cost and revenue calculator, an expense ratio comparison calculator, a profit margin calculator, etc. All these tools can save you some time and help you acquire accurate results.
Is the term cost to sales ratio clearer now?
After grasping the idea of costs and revenue and learning how to calculate expense ratio fees, your business can handle budget variances more flexibly and simply. Yet, if B2B lead generation plays a significant role in your business, it will never hurt to team up with qualified marketing and sales teams to align your goals with budgets.
Contact Belkins to learn how to get more leads and, at the same time, maintain the low cost of operations. Our experts are always happy to help propel your business growth and prosperity!
So, what is cost of revenue? After reading this guide, you should have a clearer idea of the main terms and formulas.
In the conclusion of our article, let’s quickly recap the key points:
- The CRR measures the ratio of operating expenses to revenues generated by a business.
- To calculate CRR, you have to divide the total cost by the total revenue and multiply it by 100.
- Unlike the cost of goods sold, the cost of revenue includes additional operational expenses on top of manufacturing costs.
Measuring CRR is crucial not only for budgeting your business right but also for adjusting your sales and lead generation strategies.