Businesses are primarily successful based on how much money they make or their revenue. But while anyone can roughly grasp revenue, what it means and why it’s essential, revenue as a business figure is a little more complex, especially when you compare it to other metrics like income.
Below is a breakdown of revenue in detail and how to calculate revenue using a revenue formula.
Related: Tracking These 6 Metrics Could Boost Your Sales
Revenue explained
Revenue is the money a business generates from its normal business operations, things like gross sales of products and other income streams. It is calculated by looking at the average product sales price and multiplying it by the number of units sold.
For example, a car dealership’s revenue is the combined sales price for all cars it sells in a given timeframe, like a day, week, month or quarter. Total revenue is the “top line” for gross income metric on a balance sheet or company income statement.
While revenue is an essential metric, it is distinct from other key metrics such as operating income, gross revenue and total profits. The net profit, for example, is the amount of money you get to keep or count as profits based on the sale of goods.
Types of revenue
You can calculate and analyze different types of revenue for your business purposes or for calculating other ratios.
Related: How to Forecast Revenue and Growth
Generally, corporate revenue is subdivided according to the divisions or products that make that revenue. For instance, if you have a restaurant, you might divide and analyze your revenue by categorizing your offerings as sides, main dishes and alcoholic beverages.
Alternatively, a company can distinguish revenue by analyzing cash flow from tangible or intangible products or services. Tangible products are products you can feel and physically sell to customers, while intangible products are usually services, such as internet and cloud services.
You can further divide your revenue into operating revenue and non-operating revenue. Operating revenue is any revenue from a company’s core business. For instance, if you run a restaurant, your operating revenue is from the food and drinks you sell to customers.
Nonoperating revenue is any revenue from secondary income sources. If you run a restaurant, your nonoperating revenue could be from sales of loyalty program cards, gift cards or restaurant merchandise, like T-shirts and mugs.
Nonoperating revenue is critical to incorporate because it can be unpredictable and nonrecurring. You might, for instance, get money through a litigation victory or selling an asset.
In any case, it’s essential to divide your revenue by source and type to understand where most of your money comes from and make smarter business decisions.
Revenue vs. Income
Revenue is distinct from income, even though the two concepts are very similar. At its core, the revenue is all the money you make from your products and services.
But income is the money you “take home” or have left over after subtracting the necessary expenses to make those products and services.
This includes the cost of goods and other operating expenses, which get taken out of your revenue. In this sense, income is closer to your gross profits than revenue taken by itself.
Example of revenue
Here’s an example:
- Say you create handmade jewelry for your online store or a platform like Etsy.
- You have to spend $100 on materials for a single set of earrings.
- When the earrings are complete, you can sell them for $150. Should you sell the pair of earrings, you’ll make a profit of $50.
In this sense, your revenue is $150, but your income is only $50. Understanding these distinctions can help you grasp your finances more accurately and responsibly.
Note that even though income is vital to calculate, it needs to consider the time or cost of labor that is not accounted for in salaries.
Again, say you run your own business and don’t employ anyone. While you can calculate income by subtracting the material expenses you have, you won’t be able to tally up the cost of your labor unless you pay yourself a salary.
Why and when is revenue important?
Revenue is essential because it helps a company understand how much money has been brought in over the last quarter, month or timeframe.
Businesses can’t make wise decisions regarding employee salaries, product purchasing and other expenses without knowing how much money flows into their coffers.
Revenue is the top-line income metric because it appears first on any corporate income statement. When you hear “top-line growth,” you can translate it in your head to “revenue growth.”
It’s contrasted with net income, also called the bottom line income metric. Income, as mentioned above, is a company’s revenues minus expenses.
Contrasting these two numbers can help companies understand how much money they spent to earn their profits. It’s one of the central accounting principles that should guide your business activities.
While revenue is significant, it cannot and should not be considered in isolation. Instead, you should look at revenue in conjunction with other metrics so you can understand the total financial health of your business relative to other organizations or your business goals.
For example, if you have high revenue, such as $1 million per quarter, you might think that you are earning a lot of money.
But when you compare your revenue to your net income, which is just $20,000 per quarter, you’ll notice that you aren’t taking home a lot of money relative to your expenses or the costs of doing business.
Armed with information about revenue vs. profit, you can then make decisions such as:
- Decreasing your expenses in some way.
- Offering new products or changing the way you price your products.
Revenue, along with profit margin, is an integral part of forecasting, fundraising from investors and accrual accounting, all of which consider a company’s financial health.
How can companies increase revenue?
Companies can increase revenue in a variety of ways. For example, a company can try to reduce its operating expenses by laying off employees, finding better supply chain arrangements or streamlining or simplifying the manufacturing process to make producing each business unit cost less.
Related: Finding New Ways to Generate Revenue
Alternatively, companies can increase revenue by increasing the cost of each unit sold. They may increase prices by a certain amount to bring in more money.
This tactic, while risky, can be successful if a company’s target audience members are willing to spend more money on the same products for one reason or another.
How to calculate revenue
You need to know how to calculate revenue if you are to analyze it properly.
Fortunately, you can use a simple revenue calculation formula to get this metric, no matter how many things you have sold or how much money you have made.
Note that this revenue formula is helpful and generalized, but service companies, production companies, and other corporations may use different formulas.
An excellent basic revenue formula to use is:
Net revenue = (quantity sold X unit price) – discounts – allowances – returns
Here’s a more detailed breakdown of this formula: net revenue is what you are trying to find.
The discounts are any discounted prices you have to account for, such as when selling products on sale.
Allowances are other monetary benefits afforded to customers, such as store credit. Returns are subtractions to your revenue because you give back money to a customer.
To complete this formula, you first multiply the units sold by the unit price for each unit. Say that you are trying to find the revenue for selling a batch of glasses from your business.
You sell each glass for $50, and you sell 75 glasses in total. You end up with a revenue of $3750.
However, you need to subtract any discounts, allowances, or returns that may have impacted that revenue number.
Say that one of your customers returned 10 of the glasses because they ended up needing fewer. You have to subtract $500 from that total, resulting in a new total of $3250. Remember, this is just your revenue, not your income or profits.
Essentially, you can always calculate revenue by calculating how much money you made, then subtracting any expenses, discounts or other elements that might reduce how much money you take home or put in the bank.
When should you calculate revenue?
You or your accountant should calculate revenue at the end of each quarter at the bare minimum. Revenue is a crucial element of any balance sheet, which collects essential metrics and shows you your company’s financial health.
However, you can calculate revenue whenever you need to understand the relationship between the money you bring in and the money you spend to make that profit.
Calculate revenue when you want to learn:
- Whether you need to increase the prices of your services or products.
- Whether you should decrease or increase your labor salaries or lay people off.
- Whether you should reduce the prices of your products to drive sales.
- Whether you need to take other, more drastic measures to improve the profitability of your company.
If you have an accountant, they may calculate the revenue for you automatically or regularly. However, it may be wise to calculate revenue regularly.
Since it’s only accurate for a short period, regularly calculating revenue could help you see how your company evolves or see what “good” revenue looks like compared to “bad.”
Summary
Revenue is just one part of a company’s overall balance sheet. While important, remember to be careful about calculating revenue in isolation; instead, consider analyzing it in conjunction with other metrics such as income, gross profits and expenses.
Running a business and understanding your finances is an ever-evolving, ongoing process.
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