What it means
Research is the search for new knowledge, often without a specific product in mind. Development is the application of that knowledge to design, build and test something that can be sold or used.
Together they cover activities such as laboratory experiments, prototype building, software engineering and pilot production runs. Companies spend on R&D to stay ahead of rivals, to meet changing customer needs and to create products that earn higher margins.
The spending is uncertain, since many projects fail and some take years to pay back. A business must therefore decide how much risk to take and how to balance short-term profit with long-term growth.
A common way to compare companies is R&D intensity, which is R&D spending as a percentage of revenue. Software and pharmaceutical firms often spend a high share of revenue on R&D, while retailers and food producers typically spend a much smaller share.
The figure helps investors judge how much a business is investing in its future. Accounting treatment varies and deserves attention.
Under US accounting rules, research and development costs are generally recorded as an expense in the period they occur, whereas international standards allow certain development costs to be capitalised, meaning recorded as an asset, once strict conditions are met. This difference can change reported profit, so analysts adjust for it when comparing companies.
Many governments encourage R&D through tax credits or deductions, which reduce the cost of qualifying spending. The rules, rates and conditions are set by each tax authority and change from time to time.
Finance teams should keep careful records of staff time, materials and contractor costs to support any claim. Managing an R&D budget is as much about discipline as generosity.
Leaders usually set stage gates, which are checkpoints where a project must prove itself before receiving more funding. This lets a company stop weak projects early and put more money behind the promising ones.
In practice
Real-world examples.
Example
A software company dedicates 40 engineers to building a new analytics feature. Their salaries and cloud testing costs are tracked as R&D, and the finance team reports the spending to the board each month. The board compares it with the revenue the feature is expected to generate, and reviews the plan again if development costs run over budget.
Example
A drinks manufacturer develops a new low-sugar recipe over eighteen months, running taste tests and small production trials. The costs of lab staff, ingredients and test equipment are recorded as R&D. After launch, the finance team compares sales with the original business case.
Example
An engineering firm claims a government tax credit for the cost of developing a more efficient pump. The finance manager gathers timesheets, invoices and project reports as evidence. The credit lowers the net cost of the project, and the finance manager records it according to the company's accounting policy.
Formula
Calculation
R&D intensity = R&D expense / revenue x 100
Suppose a medical device company has revenue of $30,000,000 and spends $2,400,000 on research and development in the year.
Step 1: divide R&D expense by revenue = $2,400,000 / $30,000,000 = 0.08.
Step 2: convert to a percentage = 0.08 x 100 = 8%.
If a competitor with $50,000,000 of revenue spends $5,000,000, its intensity is $5,000,000 / $50,000,000 = 10%, so it invests proportionally more.Case study
Seen in the real world.
Brightpath Devices is a fictional manufacturer of home health monitors, used here for illustration. Its revenue was $30,000,000, and R&D spending was $2,400,000, or 8% of revenue. Competitors were spending closer to 10%, and sales of the older model were starting to slow.
In this illustrative story, the board agreed to raise R&D spending to 10% of revenue and introduced stage gates, so that projects received funds in steps. Two weak ideas were stopped after the first gate, and the money was moved into a promising new sensor. Two years later the new product accounted for a quarter of sales.
The finance team also reported R&D intensity and the number of projects at each gate in every board pack. Directors said this made it much easier to see whether the extra money was producing results. Brightpath later applied for a research tax credit, supported by the same project records.
Watch out
Common mistakes.
- Cutting R&D to boost short-term profit without thinking of the future. It may improve this year's results but weaken the product pipeline.
- Assuming all R&D is expensed. Some development costs can be capitalised under certain accounting standards.
- Ignoring tax incentives. Many governments offer credits or deductions for qualifying R&D.
Questions
People also ask.
What is R&D intensity?
It is R&D spending as a percentage of revenue, used to compare how much firms invest in innovation.
What is the difference between research and development?
Research looks for new knowledge, while development applies that knowledge to create or improve a product or process.
Is R&D an asset or an expense?
It depends on the accounting rules, since many are expensed immediately and some development costs can be recorded as assets.
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