Revenue is the money a business earns from the sale of goods and services. Also known as the top line, revenue is a key metric that demonstrates a company’s growth and performance.
What Is Revenue?
Revenue is generated by a business’s core operations. It consists of the money a business earns from sales of its goods and services, minus any returns, discounts or allowances.
For example, a cleaning business earns revenue when it provides cleaning services to a customer, perhaps priced by the visit or hour. Some businesses may have revenue from both products and services—for instance, a manufacturer of factory tools might collect product revenue from selling equipment and service revenue from maintaining that equipment.
- Revenue is the sales a company generates by providing goods or services to its customers.
- This key number is calculated by subtracting the cost of returns, discounts and allowances from the total amount of money generated by sales.
- Revenue is a critical metric that demonstrates business growth and performance.
Revenue on the Income Statement
Net revenue is listed on the first line of a company’s income statement, which is why it’s sometimes simply called the top line. In addition to reporting total revenue, some companies report their revenue breakdown by product line or service line.
Organizations may also categorize revenue into operating revenue and non-operating revenue, depending on whether it resulted from core business activities or something else (more on this later).
Revenue is the starting point for calculating a company’s profit. After subtracting cost of goods sold and operating expenses, revenue becomes operating income. This combined with non-operating income, less interest, taxes and other non-operating expenses reveals the company’s net income, otherwise known as its net profit or bottom line.
Why Is Revenue Important for Your Business?
Revenue is a measure of the company’s success in generating sales. It’s also a key measure of business growth, since companies generally grow by increasing revenue.
Revenue is influenced by the price of products or a service offering as well as the number of units sold. Discounts can increase sales but result in lower revenue, depending on how many units are sold at the lower price. On the other hand, seasonal surges in demand or successful marketing initiatives can increase the number of units sold without requiring price reductions, resulting in higher revenue. In fact, many companies determine the success of marketing efforts or promotions by looking at its impact on revenue.
What Is Income?
Income and revenue, while related, are different. While revenue accounts for cash coming into the company in cash account, businesses calculate operating income by subtracting expenses from that revenue. Although some treat revenue and income as synonyms, when finance professionals talk about “income,” they usually mean gross revenue or net income—revenue minus expenses—and not the raw revenue number.
Revenue vs. Income
Though the term revenue is most commonly applied to sales of a product or service, companies can also generate income from other sources that are not related to its core operating activities or sales revenue, such as interest from investments. Typically, companies report only the net gain or loss from these sources of non-operating income. These values are listed as non-operating income or sometimes as “other” income on a company’s income statement.
Types of Income
In addition to any non-operating income, companies typically calculate and report several different types of income:
- Gross income, or gross profit, is a measure of the profitability of a company’s products or services. It is calculated by subtracting the cost of goods sold (COGS) from revenue. COGS includes only the costs directly related to the production of goods or services.
- Operating income is calculated by subtracting operating expenses from gross income. Operating expenses are all of the indirect costs required to operate a business. They include COGS—the direct costs associated with a company’s core business—and other costs such as depreciation and amortization.
- Net income is the profit after subtracting all costs, including taxes and non-operating expenses. Because of this, net income is typically lower than gross or operating income.
Revenue vs. Net Income
Generally, if revenue increases, net income should increase as well. However, this won’t be the case if operating or non-operating expenses grow faster than sales.
If manufacturing, selling or administrative costs rise faster than sales, a company’s net income could still shrink, even if revenue climbs. If revenue is up but net income is down, a business needs to identify the causes and look for ways to cut costs. Conversely, it’s possible to increase net income even if revenue is static by implementing more efficient production or administrative processes.
In addition, because net income also includes non-operational expenses, one-time events like a major lawsuit, the sale of a subsidiary or an asset write-down can outweigh the effect of any changes in revenue or operating expenses.
Revenue and Bookkeeping/Accounting
The way that a company reports revenue depends on the accounting method it uses. There are two primary accounting methods: cash basis and accrual basis. Cash basis accounting is simpler, but accrual basis accounting can give a more accurate picture of a company’s financial position. While small companies often use cash basis accounting, accrual accounting is required for all publicly-traded companies and many other larger organizations, including businesses with annual revenue of more than $25 million. In addition, Generally Accepted Accounting Principles (GAAP), a set of accounting standards issued by the Financial Accounting Standards Board (FASB), mandate accrual basis accounting.
In cash accounting, revenue from the sale of a product or service is recorded in the general ledger when the payment is received, independent of when the company delivers the product or service. Expenses are recorded when the company spends money to purchase goods and services.
Revenue Recognition Principle
Accrual accounting aligns with two important GAAP principles: the revenue recognition principle and the matching principle. The revenue recognition principle means that revenue is recorded on the income statement at the time it is earned, regardless of when the invoice is paid. The matching principle means that all costs related to generating the revenue are also recorded within the same period.
The way that revenue is recognized in accrual accounting can smooth out revenue swings on the income statement, enabling better year-over-year comparisons. For example, if the company is paid upfront for a multi-year service contract, with accrual accounting, it spreads out the revenue over the life of the contract. In contrast, with cash accounting, the company would report all the revenue in year one and no revenue in the subsequent years of the contract.
To calculate revenue, total all sales and subtract returns, discounts and allowances. The formula for revenue is:
The revenue formula can be stated as follows:
Net Revenue (Net Sales) = Unit Price x Units Sold – (Discounts + Returns + Allowances)
Sales tax is not counted as revenue. Instead, sales tax becomes a current liability on the balance sheet until the taxes are remitted to the government.
To illustrate how revenue is calculated, let’s use a simple example of an ecommerce site that sells a single product: a cellphone stand. During the current accounting period, the web store sold 100 stands at the standard price of $4.50, and 120 stands at a 20% discount ($3.60):
100 units at $4.50 = $450
120 units at $3.60 = $432
During the same period, the store had two returns at the original price:
2 units at $4.50 = $9
The store calculates revenue as:
$450 + $432 – $9 = $873
Here’s another example of a business that generates its revenue from services rather than products. A small office cleaning company has three tiers of pricing for weekly cleaning, depending on the size of the office. To find its total revenue for the week, the business multiplies the number of clients in each pricing tier by the number of cleanings.
Tier 1: 20 clients x $150 = $3,000
Tier 2: 12 clients x $200 = $2,400
Tier 3: 8 clients x $250 = $2,000
All the clients were happy with the cleaning service, so there are no refunds for this week.
Calculating the week’s revenue for the cleaning company simply involves totaling the price of each cleaning for all 40 clients:
$3,000 + $2,400 + $2,000 = $7,400
Forecasting revenue is an essential element of business planning. In addition, lenders usually require a sales forecast when considering whether to offer a company a small business loan. Companies can forecast revenue based upon data from within the company as well as consumers and the industry. Using financial statements and predicted demand combined with historical performance, you multiply the number of expected units to be sold by the average selling price.
Financial forecasting is often a complex task, since sales can be influenced by many different variables, including economic conditions, revenues and expenses, and may also include cash flow, gross margin, etc. as well as competition and production issues.
One financial forecasting method is simply to make projections that assume historical trends will continue, adjusting for seasonal variations. More complex methods include regression models that take into account multiple internal and external factors.
Using Financial Management Software for Revenue Forecasts
Companies can use planning and budgeting software to automate forecasting, allowing teams to collaborate on planning based on data gathered from across the company. The U.S. Bureau of Labor Statistics produces data that can be used in revenue forecasts, including consumer spending surveys and industry-specific statistics.
When someone launches a business, revenue is one of the first numbers they will pay attention to, and for good reason. It’s a crucial metric in assessing the financial health and future outlook of a company. Only when an organization knows its revenue can it determine whether it’s profitable or needs to cut back on spending and on an upward or downward trajectory.