UNDERSTANDING THE CONCEPT OF REVENUE
Revenue is the money that a company receives from customers in exchange for goods and services. It is the amount of money that flows in from customers. Revenue consists of two parts: sales revenue and cost of sales.
Revenue is also one of three main financial statements that business owners use to assess the performance of their organization. The other two statements are expenses and net income.
Sales revenue is the total amount of money that a company receives from selling its products or services during a given period of time. It includes all income generated by selling goods or services to customers, including both gross profit and net profit (the difference between gross profit and operating expenses).
The formula for calculating sales revenue is:
Revenue = Volume x Price x Margin
Volume = Units Sold x Average Price per Unit
Price = Cost Per Unit – Manufacturing Overhead Cost – Marketing Overhead Cost
Margin = Gross Profit / Sales Revenue
It is important to remember that more sales do not automatically mean more profit (although there are some cases where it does). For example, if you sell software and your customers pay you in advance, you won’t make any money until your customers get their copies of the software that they bought from you. In a similar way, if you own a website and sell ads on it (which is how the vast majority of websites make most of their money), the ads won’t make you any money until someone clicks on them.
The revenue recognition principle in accounting says that revenue is recorded when the benefits and risks of ownership have moved from the seller to the buyer or when services have been delivered.
Notice that this definition doesn’t say anything about receiving payment for goods or services. This is because companies often sell their goods to customers on credit, which means they won’t get paid right away.
When goods or services are sold on credit, they are counted as income, but since the cash payment has not yet been received, the value is also counted as accounts receivable on the balance sheet.
When the cash payment comes in later, there is no extra income recorded, but the cash balance goes up and accounts receivable go down.
Revenue on the Income Statement (and other financials)
The more sales a company makes, the easier it is for it to pay its employees, buy inventory, pay its suppliers, invest in research and development, build new property, plant, and equipment (PP&E), and stay self-sufficient. Sales are the lifeblood of a business.
If a company doesn’t make enough money to cover these costs, it will have to spend money that is already on its balance sheet. The money can come from financing, which means that the company either raised the money (in the case of equity financing) or borrowed it (in the case of debt financing) (in the case of equity).
To do a thorough analysis of a company, you need to know how the three financial statements work together and how a business gets its operating capital from sales or has to find other ways to pay for it.