What is Cost of Revenue?

Cost of goods sold: the goods part
Why a service business doesn't have COGS

Cost of revenue is the direct cost of earning a period's revenue: what it cost you to make or buy the goods you sold and to deliver the services you billed. You subtract it from revenue to get gross profit. Cost of goods sold (COGS) covers only the goods. A business that sells services, or both goods and services, also has the direct cost of delivering those services, so its cost of revenue is wider than COGS.

Billed publishes this page. The accounting wording below comes from the open textbook Principles of Accounting, Volume 1: Financial Accounting (OpenStax), section 6.1. The US tax wording comes from IRS Publication 334 (2025), Tax Guide for Small Business, and the SEC wording from 17 CFR 210.5-03 (Regulation S-X) on eCFR. All were opened on October 29, 2026. This is general information, not accounting or tax advice; ask your accountant how to classify your own costs.

Cost of goods sold: the goods part

OpenStax defines COGS for a business that sells products: "The cost of goods sold (COGS) is an expense account that houses all costs associated with getting the product ready for sale. This could include purchase costs, shipping, taxes, insurance, stocking fees, and overhead related to preparing the product for sale."

It's recorded when the goods are sold: "By recording the cost of sale when the sale occurs, the company aligns with the matching principle."

For a merchandiser, OpenStax notes that the income statement must "first resolve any sale reductions and merchandise costs, known as Cost of Goods Sold, before determining other expenses and net income (loss)." Its figure caption adds: "Cost of Goods Sold is deducted from net sales to calculate gross margin."

Why a service business doesn't have COGS

OpenStax: "A service company provides intangible services to customers and does not have inventory." In its simple service company income statement, "Expenses are subtracted directly from Sales to produce net income (loss)", with no COGS line.

So COGS is tied to goods and inventory. A service business still has costs that come directly from delivering its work, such as contractors or staff doing client work and materials used on a job. Grouping those costs above gross profit, as a cost of revenue or cost of services, shows what each period's work cost to deliver. Which costs go there is a classification choice, so agree on it with your accountant and apply it the same way every period.

Cost of revenue vs COGS vs operating expenses

COGS: the cost of the goods you sold (purchase or production cost, freight-in and other costs of getting the product ready for sale).
Cost of revenue: COGS plus the direct cost of delivering services, for a business that sells both, or the direct cost of services alone for a pure service business.
Operating expenses: costs of running the business that aren't tied to delivering a particular sale, such as rent, marketing and general admin. They sit below gross profit. See operating income.

For SEC-reporting companies (US). Regulation S-X lists the line items for the income statements it covers. Under the caption "Costs and expenses applicable to sales and revenues", it says: "State separately the amount of (a) cost of tangible goods sold, (b) operating expenses of public utilities or others, (c) expenses applicable to rental income, (d) cost of services, and (e) expenses applicable to other revenues." Regulation S-X says the purpose of that section is to indicate the line items that "should appear on the face of the statements of comprehensive income filed for the persons to whom this article pertains". Ask your accountant which presentation rules, if any, apply to your statements.

Worked example: a studio that sells goods and services

The business and figures here are a sample, invented for this example.

A design studio's quarter:

Revenue: design services $40,000 + printed products $20,000 = $60,000.

Step 1: COGS for the printed products.

Beginning inventory $3,000 + purchases $9,000 = $12,000 of goods available.
Less ending inventory $4,000.
COGS: $12,000 − $4,000 = $8,000.

Step 2: direct cost of the design services.

Freelance designers working on client projects: $12,000.
Stock images licensed for client jobs: $1,000.
Cost of services: $12,000 + $1,000 = $13,000.

Step 3: cost of revenue and gross profit.

Cost of revenue: $8,000 + $13,000 = $21,000.
Gross profit: $60,000 − $21,000 = $39,000.
Gross margin: $39,000 ÷ $60,000 = 65%.

Step 4: operating expenses and operating income.

Rent $6,000 + marketing $2,000 + software and admin $1,000 = $9,000.
Operating income: $39,000 − $9,000 = $30,000.

Why the label matters. If the studio deducted only COGS above gross profit and put the $13,000 of freelance costs in operating expenses, gross profit would read $60,000 − $8,000 = $52,000, a margin of 86.7% (rounded). Operating income is $30,000 either way ($52,000 − $22,000). Only the gross line changes, and the 86.7% figure would hide what the design work cost to deliver.

US tax: cost of goods sold on Schedule C

For US sole proprietors, IRS Publication 334 says: "If you make or buy goods to sell, you can deduct the cost of goods sold from your gross receipts on Schedule C (Form 1040). However, to determine these costs, you must value your inventory at the beginning and end of each tax year."

For businesses without merchandise, it says: "You don't have to figure the cost of goods sold if the sale of merchandise is not an income-producing factor for your business. Your gross profit is the same as your net receipts (gross receipts minus any refunds, rebates, or other allowances)."

Schedule C's COGS section (lines 35 to 42) starts with beginning inventory, adds purchases, cost of labor, materials and supplies and other costs, and subtracts ending inventory. How you label costs in your own reports doesn't change what goes on the tax form, so ask your accountant how your costs map to Schedule C.

Common mistakes

Putting the direct cost of client work, such as subcontractors, in operating expenses, which makes gross margin look higher than the work earns.
Putting rent, marketing or admin in cost of revenue, which makes it look lower.
Changing the classification from one period to the next, so margins can't be compared.
Counting goods you bought but haven't sold as COGS, instead of leaving them in inventory until they're sold.

Where Billed fits

Billed publishes this page. Its expense tracking page says an expense in Billed records "who you paid, when, how much and which category it belongs to, with the receipt attached to the same entry", and that "Billed's expense report can group your expenses by category." Use separate categories for direct job costs, such as subcontractors and job materials, and for overhead, so you can total cost of revenue for a period. Billed's financial reporting page also describes an "Income vs Expense report" for seeing how profitable the business is. Billed's invoice software page says: "When a client pays by check or cash, record it as an offline payment so all your income is in one place."

When this guide isn't for you

This page covers cost of revenue for small businesses. If you prepare financial statements under US GAAP or for SEC filings, hold significant inventory, or need inventory costs for tax, work with an accountant on the rules that apply.

Frequently Asked Questions

What is the difference between cost of revenue and cost of goods sold?

Cost of goods sold is the cost of the goods you sold: what it took to buy or make them and get them ready for sale. Cost of revenue is wider. It adds the direct cost of delivering services, so a business that sells services, or both goods and services, can show all of its direct delivery costs above gross profit.

Does a service business have cost of goods sold?

Not in the inventory sense. OpenStax describes a service company as one that provides intangible services and doesn't have inventory. A service business can still group the direct cost of delivering its work, such as contractors on client projects, as a cost of revenue or cost of services.

What goes into cost of revenue?

The direct costs of what you sold in the period: COGS for any goods, and for services the direct cost of delivering them, such as contractors or staff time on client work and materials used on a job. Rent, marketing and general admin are operating expenses instead.

How do you calculate gross profit from cost of revenue?

Subtract cost of revenue from revenue. For example, revenue of $60,000 and cost of revenue of $21,000 give gross profit of $39,000, a gross margin of 65%.

Do I have to figure cost of goods sold for taxes?

For US sole proprietors, IRS Publication 334 says you can deduct cost of goods sold on Schedule C if you make or buy goods to sell, and that you don't have to figure it if selling merchandise isn't an income-producing factor for your business. Ask your accountant how this applies to you.

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What Is Cost of Revenue? A Simple Guide for Small Business