Revenue is the amount of money a company receives in exchange for its goods and services or conversely, what a customer pays a company for its goods or services. The revenue received by a company is usually listed on the first line of the income statement as revenue, sales, net sales, or net revenue.
Companies pay more attention to this single line item than any other as it is the greatest factor that determines how their business is doing. It tells a company clearly how much money it is bringing in from the sale of its product.
How to Calculate Revenue
There is a standard way that most companies calculate revenue. Regardless of the method used, companies often report net revenue (which excludes things like discounts and refunds) instead of gross revenue.
For example, if a company buys shoes for $60 and sells two of them for $100, and offers a 2% discount if the balance is paid in cash, the gross revenue that the company reports will be (2 x $100) = $200. The company's net revenue will be equal to ($200*0.98) = $196. The $196 is normally the amount found on the top line of the income statement.
The most simple formula for calculating revenue is:
Number of units sold x average price
Number of customers x average price of services provided
Expenses and other deductions are subtracted from a company's revenue to arrive at net income.
How Do Companies Calculate Revenue?
In a financial statement, there might be a line item called "other revenue." This revenue is money a company receives for activities that are not related to its original business. For example, if a clothing store sells some of its merchandise, that amount is listed under revenue. However, if the store rents a building or leases some machinery, the money received is filed under "other revenue."
There is a practice among companies to leave the "other revenue" line fairly slim in order to prop up the top line (net revenue) if it was a disappointing earnings quarter. This is true especially for companies that are heavily watched and traded, as the top line is the figure that is projected by investment sites, and is the number that is most commonly used to determine how a business is performing.
Revenue is recorded at the time of the sale when the products or services exchange hands. Revenue is not recorded when payment is received, but rather beforehand. This is so because companies often sell items on credit that is to be paid later. On a company's balance sheet, this line item is accounts receivable; the amount that the company is expected to collect as revenue.
When payment is finally made, revenue is not increased as it was already recorded. On the balance sheet, accounts receivables are decreased and cash increases.
What Revenue Reporting Is Used For
Revenue is very important when analyzing gross margin (revenue - cost of goods sold) or financial ratios like gross margin percentage (gross margin/revenue). This ratio is used to analyze how much a company has left over after the cost of the merchandise is removed.
As you can imagine, companies can become almost artistic with how they handle their top line. For example, if they wanted to lower the cost of their merchandise so that their top-line margins would appear larger, they could lease the merchandise or offer it at a premium. Using such a method would incur a higher net revenue than if they were to simply sell the product or service at its base cost.
The Bottom Line
The process of calculating a company's revenue is rather straightforward. However, accountants can adjust the numbers in a legal way that makes it necessary for curious parties to dig deeper into the financial statements to get a better understanding of revenue generation rather than just looking at a cursory figure. This is especially true for investors, who need to know not just a company's revenue, but what affects it quarter to quarter.