What’s The Difference Between Cost of Revenue and Operating Expenses?

Has this ever happened that you are business owner, and you are looking at your income statements and start wondering why are there so many types of costs? Yeah, you are not alone in this, because these things do exist, but right now here our focus our the two most misunderstood cost terms:

• Operating Expense

• Cost of Revenue

These might sound like some jargons that only people in the meeting room use, but that’s not really the truth. When owning a business, you should be familiar with these two terms, and like really should know the difference between them.

If you don’t know about these then no need to panic, we are here now and we are going to explain every little thing in the easiest way possible, say good-bye to heavy wordings and read everything carefully.

What Is Cost Of Revenue?

Think of Cost of Revenue as everything you directly spend to make your product or deliver your service. If you’re selling handcrafted furniture, the wood, nails, tools, the wages of the people assembling the tables, and even the electricity in your workshop — those costs go into your cost of revenue.

It’s what stands between your raw materials and your final product landing in the hands of your customer.

In accounting terms, Cost of Revenue includes both direct and indirect costs tied directly to production or service delivery, such as:

• Raw materials
• Labor (direct and indirect)
• Utilities for production facilities
• Depreciation of production equipment

This figure appears on your income statement, typically just below revenue, and it directly impacts your gross profit.

How To Calculate the Cost of Revenue

Here’s the good news: You don’t need to be a CPA to calculate your cost of revenue. All you need is a solid grasp of your production expenses and a calculator (or a spreadsheet you trust).

Cost of Revenue Formula:

Cost of Revenue = (Cost of Raw Materials) + (Indirect Materials) + (Employee Wages) + (Indirect Labor) + (Production Facilities Costs)

Here are the proper steps to take to calculate properly:

1. Identify how much you spent on raw materials. Wood, steel, fabric — whatever you need to physically make or deliver your product or service.
2. If you purchased indirect materials, like glue or paint to support production, include their costs.
3. Assess how much you spent on employee wages who were directly involved in making the product or providing the service.
4. Include any indirect labor costs — maybe a quality control person or machine maintenance team.
5. Don’t forget the cost of production facilities like electricity, rent, and depreciation on equipment.
6. Add it all up. Boom — that’s your Cost of Revenue.

Example: 

Let’s say you own a small artisanal chocolate company (yum!). Last month:

• Raw materials (cocoa, sugar, milk): $8,000
• Indirect materials (packaging, wrappers): $1,200
• Employee wages (chocolatiers): $6,500
• Indirect labor (QA specialist): $1,000
• Utilities for production: $1,300

Total Cost of Revenue = 8,000 + 1,200 + 6,500 + 1,000 + 1,300 = $18,000

If your revenue from chocolate sales was $30,000, your gross profit would be $12,000.

What Is an Operating Expense?

Now that we’ve tackled the cost of getting your product out the door, let’s talk about the other slice of the pie, Operating Expenses.

These are all the costs of running your business that aren’t directly involved in making or delivering your product.

Think:

• Rent
• Utilities (for your office, not production)
• Office supplies
• Legal costs
• Sales and marketing
• Payroll (for non-production staff)
• Insurance

If it’s necessary to operate your business but doesn’t touch your actual product or service delivery, it likely falls under operating expenses.

How to Calculate Operating Expenses

Operating expenses can feel trickier because they’re scattered across different parts of your business. But the process is straightforward if you’re organized.

Operating Expenses Formula:

Operating Expenses = (Office Supplies) + (Accounting Supplies) + (Insurance) + (Legal Fees) + (Licensing Fees) + (Marketing) + (Payroll) + (Maintenance & Repairs) + (Travel) + (Taxes) + (Rent & Utilities)

Here are the proper steps to take to calculate properly:

1. Create a list of all the categories your business spends on that aren’t related to producing a product.
2. Tally how much you spent in each of those categories over a specific period (e.g., monthly or quarterly).
3. Add it all up — that’s your Operating Expenses.