How Companies Calculate Revenue

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.

Aside from the bottom-line (net income), companies pay more attention to this single line item than any other. 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.

Changes in revenue can be analyzed to determine if marketing strategies are working, how price changes affect the demand for the product, and a multitude of other insights.

Key Takeaways

• Revenue is another word for the amount of money a company generates from its sales.
• Revenue is most simply calculated as the number of units sold multiplied by the selling price.
• Because revenues do not account for costs or expenses, a company’s profits, or bottom line, will be lower than its revenue.

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How Do Companies Calculate Revenue?

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, a company buys pairs of shoes for $60 and sells each pair for $100. They offer a 2% discount if the customer pays with cash. If the company sells two pairs of shoes to a customer who pays with cash, then the gross revenue reported by the company will be $200 ($100 x 2 pairs). However, the company’s net revenue must account for the discount, so the net revenue reported by the company is $196 ($200 x 98%). This $196 is the amount that would normally be found on the top line of the income statement.

The most simple formula for calculating revenue is:

• Number of units sold x average price

Also:

• Number of customers x average price per unit provided

Expenses and other deductions are subtracted from a company’s revenue to arrive at net income.

Other 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 from this business activity is filed under “other revenue.”

Recording Revenue

Revenue is recorded on a company’s financial statements when it is earned, which might not always align with when cash changes hands. For example, some companies allow customers to buy goods and services on credit, which means they will receive the goods or services now but will pay the company at a later date.

In this case, the company will record the revenue on the income statement and create an “accounts receivable” account on the balance sheet. Then, when the customer pays, the accounts receivable account is decreased; revenue is not increased because it was already recorded when it was earned (not when the payment was received).

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 profit a company has made after the cost of the merchandise is removed but before accounting for other expenses.

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.