Posted by Tasnim Ahmed
April 21, 2021 | 4-minute read (722 words)
Companies new and old base their existence primarily on one thing: revenue. How much revenue are they earning, and how much of it are they spending. But how is revenue actually defined? In plain terms, revenue is the amount of cash inflow a company has after selling its products, services, assets and/or capital in a certain period, usually one year. Revenue is the lump sum amount that the company gets in its coffers before costs and expenses. Once cost and expenses are deducted from the total revenue figure, it is then termed as the net profit. Note that while most companies calculate annual revenue, some assess quarterly or half yearly revenue.
But how is revenue calculated? Annual revenue is the summation of items sold, multiplied by their base price. In a formula, it’ll look like the following.
Annual revenue = unit price x number of items sold
For example, Company Y makes and sells popsicles. The number of popsicles sold in a year at the current price would be its revenue. Let’s say you sold 200,000 popsicles in 12 months at a dollar a piece. By applying the formula we find that:
annual revenue = 1 × 200,000 = $200,000
In other words, $200,000 is Company Y’s annual revenue for the past year. But it can’t be that Y has produced that many popsicles without incurring some costs and expenses. Let’s say you have four permanent employees including yourself, and everyone's combined annual salaries add up to $130,000. Additionally, you have two temporary employees whom you pay $20,000 annually. Coupled with salaries, electricity, rent, permits and raw materials together cost you an additional $20,000 annually. So, in the end your net profit will be as follows:
Net profit = annual revenue - cost - expenditures
$200,000 - $130,000 - $20,000 - $20,000 = $30,000
Therefore, $30,000 is Company Y’s net income for that year. As you might notice, the figures for annual revenue and net income normally are vastly different.
Apart from sales and services that your company earns in revenue, there might also be other revenue sources. For example, perhaps this year the usefulness of a particular piece of machinery subsided, but it’s still in good working condition and you sell it for $15,000. This figure represents nonoperating revenue, defined as the money your company earns from non-sales activity.
Nonoperating revenue can be derived from many sources, such as:
Asset or capital sale: Like the machine sold in the example above. When selling a machine you no longer use to another company, its sale price is part of your annual nonoperating revenue.
Dividend/interest/rent revenue: Companies may own shares of other businesses, and these stocks may provide good returns. These dividend returns are part of the company’s nonoperating revenue. Likewise, your company might have offered loans for which you receive interest. This also is a part of nonoperating revenue. The same goes for rent earned from your company’s real estate holdings.
Depreciation revenue: Also known as contra revenue, this is the only type of revenue that is negative in nature. Unpaid invoices or unsold inventory all account for depreciating revenue.
Don’t be misled by revenue growth!
Typically, revenue growth figures are cited as percentages. Be careful, as this can present a skewed picture. For example, last quarter's revenue was $200,000 but this quarter it was $350,000. On the face of it, quarterly revenue growth would look like this:
Revenue growth rate: [revenue period B - revenue period A] / revenue period A X 100
quarterly revenue: ($350,000 - $200,000) / $200,000 = 0.75 X 100, indicating a 75% increase in quarterly revenue.
But don’t forget to consider expenditures and costs for the quarter. Revenue growth alone doesn’t convey the full picture about your business.
Recap: To better understand the financial health of your business, it's important to understand these essential formulas for calculating annual revenue. And companies seeking investors especially need to understand revenue growth and how it tallies over multiple quarters rather than a single snapshot. Stay clear of misleading numbers, and keep an eye on revenue and expenditures to make the correct calculations.