What is Revenue?

Revenue is the total sales of a business within a reporting period. It is a quantification of the gross activity generated by a business, which is the average unit price charged to customers, multiplied by the number of units sold. Revenue is generally created when either goods or services are sold. However, it may also include other activities, such as the sale of memberships or subscriptions.

How to Calculate Revenue

Revenue is typically calculated based on the unit sales of a business, where the number of units sold is multiplied by the unit price. The formula is as follows:

Number of units sold x Unit price = Gross revenue

In reality, the final revenue figure reported by a business is more complicated. The gross revenue figure will be reduced by sales allowances and other deductions, perhaps for volume purchase discounts by customers. It is also reduced by product returns from customers, which can be substantial in some industries, such as the retail sector. Thus, a more complete revenue calculation is as follows:

(Number of units sold x unit price) - Sales allowances - Sales returns = Net revenue

Revenue can be calculated for a provider of services by multiplying the average service price by the number of units of service provided. For example, a massage service charges $80/hour, and provides 1,000 one-hour massages, resulting in $80,000 of revenue.

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Revenue Recognition

Revenue Recognition

Under the accrual basis of accounting, revenue is usually recognized when goods are shipped or services delivered to the customer. This means that revenue can be recognized even though the customer has not paid yet. Instead, the revenue and the associated account receivable are recorded. Once a customer pays, the cash balance of the business increases, and the associated account receivable is eliminated from the accounting records. Depending on the credit terms, cash receipt may occur in a later reporting period than when the revenue was recognized.

Under the cash basis of accounting, revenue is usually recognized when cash is received from the customer following its receipt of goods or services. Thus, revenue recognition is delayed under the cash basis of accounting, when compared to the accrual basis of accounting. There were many standards governing revenue recognition, which have been consolidated into a GAAP standard relating to contracts with customers. The Securities and Exchange Commission imposes more restrictive rules on publicly-held companies regarding when revenue can be recognized, so that revenue may be delayed when collection from customers is uncertain.

Deductions from Revenue

There are several deductions that may be taken from revenues, such as sales returns and sales allowances, which can be used to arrive at the net sales figure. Sales taxes are not included in revenue, since they are collected on behalf of the government by the seller. Instead, sales taxes are recorded as a liability.

Presentation of Revenue

Revenue is listed at the top of the income statement. As such, it is considered to be the “top line” reported by a business. It may be reported in more detail, where gross revenue is reported first, followed by a line item for sales returns and allowances (which is a deduction), followed by the net amount of sales.

A variety of expenses related to the cost of goods sold and selling, general, and administrative expenses are then subtracted from revenue to arrive at the net profit of a business.

Types of Revenue

Revenue can be broken down into operating and non-operating revenue. The bulk of all revenue generated by a business is usually operating revenue, with rare exceptions. These revenue types are described below.

Operating Revenue

The bulk an organization’s revenue is usually derived from its core operating activities, and so is known as operating revenue. For example, the operating revenue generated by a producer of lawn mowers comes from its sale of lawn mowers and any servicing fees it charges to customers. Or, a landlord generates operating revenue from tenant rent payments, while a medical office generates operating revenue from the fees charged for its medical services. Operating revenues tend to be fairly predictable over time.

Non-Operating Revenue

Alternatively, a business may also generate additional revenue from other activities outside of its core operating activities, which is known as its non-operating revenue. A typical example of non-operating revenue is the income from invested funds. Other non-operating revenue sources are from litigation awards and the sale of assets. It can be quite difficult to forecast non-operating revenue.

Accrued and Deferred Revenue

A business may need to accrue revenue when it has delivered goods or provided services, but is unable to issue an invoice to formally record the revenue. This situation typically arises when a customer only wants to be billed at the end of a project or delivery period. In the interim, the seller accrues revenue in order to recognize revenue in the reporting period in which it was generated. When the final invoice is eventually issued, the seller reverses the accrued revenue in its accounting records.

A business may need to defer revenue when it has been paid in advance by a customer, but has not yet earned the associated revenue. In this case, the customer payment is recorded as a liability, rather than revenue. Once the associated goods or services are provided to the customer, the liability is eliminated and replaced with revenue on the books of the seller.

Revenue accruals and deferrals are only used when a business uses the accrual basis of accounting. Accruals and deferrals are not used under the cash basis of accounting.

Revenue vs. Income

Revenue is generated by the sale of goods or services to customers, while income is the amount remaining after all expenses have been subtracted from revenue. Thus, revenue appears in the top line of an income statement, while income appears in the bottom line. Revenue only reflects the ability of a business to sell goods and services at a gross level; it does not measure the efficiency with which those sales were made, which is reflected in the income figure. This means that a business might report substantial gains in revenue, and yet report a loss - possibly because it was selling goods at such a low price that it is impossible to earn a profit. Investors tend to focus more on the income figure, since it is a better representation of the sustainable financial performance of a business.