Research and Development Costs on an Income Statement
Research and Development (R&D) expenses are a type of cost you'll find under "expenses" on the income statement of some businesses, particularly those with a scientific or technological focus. R&D is the money a company spends to research and develop new products each year.
The percentage of revenue devoted to research and development expenses will depend both on the specific firm and the sector or industry in which it operates. Chemicals (including pharmaceuticals and medicines) and computers (including electronics) are two industries with the highest spending on research and development.
Examples of R&D Expenses
A pharmaceutical company spending hundreds of millions of dollars trying to discover a breakthrough drug to fight cancer would record the expense under research and development. Same with a technology company directing time and talent into developing a new piece of software. R&D can represent future growth, innovation, and, if well-managed, profits.
How much a company should spend on R&D depends on several factors. If you're trying to value a company and are examining its R&D expenses, a good place to begin is by comparing it to competitors in its industry. If most companies in a specific industry are putting 10% to 15% of sales back into R&D, and a firm you are trying to value is spending only 4%, that may be a red flag.
Take a look at some major companies and what they have spent on research and development.
Apple: The maker of the iPhone, AirPods, and MacBook increased its quarterly spending on research and development to $4.2 billion in the third quarter of 2019 or almost 8% of its quarterly revenue.
Johnson & Johnson: Johnson & Johnson spent $2.6 billion on R&D in the same quarter or 13% of its sales.
Alphabet: Google's parent company spent $6.2 billion on R&D in that quarter or about 15% of its revenue.
Amazon: The online behemoth doesn't include a line item for research and development in its quarterly report, but instead notes that these costs are included in the line item "technology and content," which recorded more than $9 billion in expenses for that quarter, or 14% of its sales.
Comparing R&D Cost
One useful exercise in evaluating a company's R&D expenses is to compare them to its past R&D spending. You can also calculate R&D expenses as a percentage of revenue as well as a percentage of gross profit. Some firms are more efficient at converting a dollar of research and development costs into a dollar of revenue. Perhaps they have better scientists, or maybe their internal processes are more conducive to entrepreneurial experimentation.
The important thing to remember is that it is not always true that more spending is better. Beware the management team that allows research and development costs to get out of control without showing any meaningful results.
R&D and Shareholders
For shareholders, R&D expenditures can be a mixed bag. On one hand, shareholders should be excited to see a company using cash to invest in itself, as this often helps the company grow and boost its share value. But this also means that a company is less likely to pay out dividends to shareholders.