R&D costs can range from nothing to billions of dollars, depending upon the type of business you are analyzing. Unlike many other costs (such as income taxes), management is almost entirely free to decide how should be spent on research and development. In 2001, Eli Lilly, one of the world's largest pharmaceutical companies, plowed nearly 26% of the total gross profit back into R&D.
How much should a company spend on R&D? It depends. In highly creative and fast-moving industries, the amount of money spent on the research and development budget can literally determine the future of the business. If Eli Lilly stopped funding the development of new drugs, its future profitability would suffer, causing a perhaps permanent decline in earnings. In such cases, it may be appropriate to compare the level of R&D funding to profitability over time, as well as to the percentage of gross profit competitors spend on research and development.
This page is part of Investing Lesson 4 - How to Read an Income Statement. To go back to the beginning, see the Table of Contents.