Revenue is how much money a business brings in by selling its goods or services at a certain price. Revenue is the starting point of a company's income statement that will determine how much net income it makes after expenses, taxes, and interest are taken into consideration. It is one of the most important line items for a business.
Though revenue is one number, there are many different ways to look at it that can provide different insight that is helpful to a business or investor. Two of the most common forms of revenue are total revenue and marginal revenue.
- Revenue is the total amount of money a company brings in from selling its goods and services at a specific price.
- The starting point for any income statement is revenue that will eventually lead to net income after expenses are deducted.
- Total revenue is the full amount of total sales of goods and services. It is calculated by multiplying the total amount of goods and services sold by their prices.
- Marginal revenue is the increase in revenue from selling one additional unit of a good or service.
- Companies will continue producing and selling more goods and services until marginal revenue equals marginal cost.
Total Revenue and Marginal Revenue
Total revenue is the full amount of total sales of goods and services. It is calculated by multiplying the total amount of goods and services sold by the price of the goods and services. Marginal revenue is directly related to total revenue because it measures the increase in total revenue from selling one additional unit of a good or service.
Total revenue is important because, in the effort to grow profits, businesses strive to maximize the difference between their total revenues and total costs. Understanding the subtleties of the relationship between revenues and costs distinguishes the best business managers from the lesser ones because while increasing production leads to an increase in sales and total revenue, there are also costs involved with increasing production.
Marginal revenue is important because it measures increases in revenue from selling more products and services. Marginal revenue follows the law of diminishing returns, which states that any increases in production will result in smaller increases in output. Meaning the optimal level has passed. Because it costs money to make and sell an additional unit, as long as marginal revenue is above marginal cost, then a company is making profits. Once the marginal revenue equals marginal cost, it makes no sense for a company to produce or sell more units of its products or services.
When a company's marginal revenue is below its marginal cost, it tends to follow the cost-benefit principle and stop production as no benefit will arise from increased production.
Calculation of Total Revenue
The calculation of total revenue frequently takes timetables into account. A restaurateur, for example, might tabulate the number of hamburgers sold in an hour, or the number of orders of medium-sized french fries sold throughout the business day. In the latter case, the total daily revenue would be the quantity (Q) of fries sold—say 300, multiplied by the price (P) per unit—say $2, per day. Therefore, the simple formula for this calculation would be:
With the values plugged into the equation, Total revenue is $600—figured by the simple arithmetic of 300 X $2.
Example of Total Revenue and Marginal Revenue
Continuing with the same example, consider what happens if the restaurateur drops the price of a unit of french fries to $1, and he heavily advertises the new discounted price. This could result in a bump in sales—let’s say to 500 units per day. Consequently, the total revenue bumps up to $500 in sales.
Total revenue changes with respect to price, and quantity can be visually demonstrated on a graph, in which a demand curve is drawn, that signals the price and quantity that would maximize total revenue.
To calculate marginal revenue, divide the change in total revenue by the change in the quantity sold. Therefore, the marginal revenue is the slope of the total revenue curve. Use the total revenue to calculate marginal revenue.
For example, suppose a company that produces toys sells one unit of product for a price of $10 for each of its first 100 units. If it sells 100 toys, its total revenue would be $1,000 (100 x 10). The company sells the next 100 toys for $8 a unit. Its total revenue would be $1,800 (1,000 + 100 x 8).
Suppose the company wanted to find its marginal revenue gained from selling its 101st unit. The total revenue is directly related to this calculation. First, the company must find the change in total revenue. The change in total revenue is $8 ($1,008 - $1,000). Next, it must find the change in the toys sold, which is 1 (101-100). Thus, the marginal revenue gained by producing the 101st toy is $8.
The Bottom Line
Total revenue is the total amount of money a company brings in from selling its goods and services. It determines how well a company is bringing in money from its core operations based on demand and price.
Marginal revenue measures the increase in revenues from selling an additional unit of a good or service, which helps management determine if it is in the best interest to produce and sell more. Once the marginal cost of producing an extra unit is greater the marginal revenue, a company will halt production as it is not making profits on the additional units sold.