Any business that’s in it is for the sake of making money. Plain and simple. That’s more or less the reason why they sell. While this is as obvious as the morning sun, understanding how that money is earned, recorded, categorized, and analyzed isn’t.
There are many different metrics, variables, and calculations involved in trying to make sense of the money that a business earns. Sales revenue appears at the top of the line of those metrics and is what gives an indication of how healthy the organization is.
Did you know that over one trillion dollars are spent every year on sales forces? If you were to ever watch Shark Tank, there’s one question you would always hear, "How much have you done in sales?" The first thing that investors are interested in and will always want to understand is if you have any revenue model in place for your business idea.
Sales bring in revenue, and revenue pays expenses. A business’s capability to pay its expenses is what creates stable opportunities for growth. An organization heavily depends on its salesforce to be able to do anything. In fact, nearly 13% of all jobs in the U.S.A are full-time sales jobs. Without sales revenue, a business will often struggle to attract suited professionals and grow its business.
There are two variants of sales revenue - net revenue and gross revenue. While both are reported on the income statement, they are very different from each other in the manner that they are calculated and the business implications they have.
For a business, returns are the money it loses to products that are returned. Whenever a customer comes across as defective or a bad product and returns it, the company’s net revenue takes a dip.
Many companies take away allowances to account for the defective products when selling them at a reduced price point. If a consumer is disposed to accept an inferior good for a lower amount, allowances make up for the difference.
Gross Revenue vs. Net Revenue
Gross sales revenue comprises of the income an organization makes through the sales of its goods, products, and services. Gross revenue generally indicates an organization’s ability to sell its products; however, it doesn’t necessarily show its ability to make profits.
Whenever gross revenue is maintained, all the income made from a sale is adjudged for on the statement of income. Expenditures from any other sources are generally not accounted for here.
In gross revenue reporting, the sales and the costs of the products that are sold are separated. Say, for instance, a tailor sells a pair of trousers for $100, and it cost the tailor $40 in total to make them. In this case, the gross revenue would still be $100. The reporting guidelines for gross revenue versus net revenue under the Generally Accepted Accounting Principles or GAAP were addressed by the Emerging Issues Task Force, or EITF 99-19.
Whereas, net sales revenue, on the other hand, shows an organization’s gross revenue after subtracting allowances and returns. It is the more accurate representation of the amount of money that a business pockets from its customers.
In net revenue reporting, only the "net revenues" items are listed, and it’s calculated by taking away the cost of the products sold from the gross revenue. For the tailor that we spoke of above, the net revenue for the pair of trousers that he sold for $100 pair, which cost him $40 to make, would be $60.
Out of that $60, the tailor would remove other costs such as packaging, labor charges, rent, and other miscellaneous charges. After all the costs that the tailor incurred to make the trousers were deducted from the gross revenue, the tailor would end up with the net revenue.
Net revenue reporting is usually done when a commission is there that needs to be accounted for and/or to acknowledge cases where a supplier receives part of the sales revenue. Legal fees of an attorney are a classic example. In this case, an attorney always takes home a percentage of the net proceeds of the lawsuit. This warrants that they acquire a high.
In the table above, the figure adjacent to Total under Revenue corresponds to the gross revenue, while the figure adjacent to Net Profit under Expense gives you your net revenue.
Why Is This Difference Important?
Oftentimes, investors and funders are more fascinated by the gross revenue because it shows your business’s ability to sell and its latency for growth. If your organization has just started a new branch at a new location, gross revenue is a far more essential metric than net revenue as it shows the potential of your business without the capital charges of opening the new branch at a new location.
However, this does not mean that you should overlook the importance of net revenue, for they are what indicate your actual profits or the real amount of money that you pocket after you have paid for everything to sell your goods. It’s the best way for you, as a business owner, to see how much money a product is bringing in and accordingly make decisions of worth and cost.
Even if a service or a product is generating you a lot of gross revenue, you can see how successful or profitable your venture is after deducting all the expenses associated with the service or the product. Many a time, you will also be able to see the places where you should and shouldn’t cut costs to help your business run more efficiently—along with seeing your best profit-generating opportunities.
The Revenue Formula: How to Calculate Revenue
Now, let’s take a look at the formula through which revenue itself is calculated. There are two main variants of the formula for calculation of revenue. These two formulas differ from each other based on whether your business is product-based or service-based. The formula for both of them is given as:
- For product-based businesses: Revenue = No. of units sold x Average price
- For service-based businesses: Revenue = No. of customers x Average price of services
Steps to Calculate Sales Revenue
- First, you have to ascertain the total number of units that are manufactured or sold during a particular period.
- After that, you have to look at the demand, which is driven by the total number of units manufactured because it makes up the basis of the function for the price, after which you calculate the average sales price per unit.
- Finally, you calculate the revenue by multiplying the total number of units sold and the average sales per unit of the product.
Let us take the case of a ceramics manufacturer that made 25 million sanitary ware pieces across different segments in a particular fiscal year.
Throughout the year, the manufacturer sold 10 million pieces of sanitary ware at an average price per unit of $70, another 10 million pieces at an average price per unit of $100, and the last 5 million pieces at an average price per unit of $200. In this case, the total revenue of the company will be determined as:
No. of units sold = 10,000,000
Average price per unit = $70
No. of units sold = 10,000,000
Average price per unit = $100
No. of units sold = 5,000,000
Average price per unit = $200
Total sales revenue = $2,700,000,000
What You Could Do With the Data
While it may seem simple to do, calculating revenue is by no means a walk in the park, and incorrect calculations have cost businesses dear. Keeping a manual record of revenues using spreadsheet formulas can cause unprecedented issues:
- Manually keeping a record of revenue can grow out of hand very soon. You should work out and keep track of when you are to receive payment for all subscriptions. Do you make a billing system? Do you charge per unit? Do you take the payment over a month’s course incrementally?
- Every change that can affect the revenue of your business has to be taken into account. For example, if you make modifications to a pricing page, you will have to revise the spreadsheets to adjudge for this.
Proper calculation of revenue is the north star by which your entire company can be guided in the right direction. It helps you ascertain all the possibilities and opportunities that you can chase and also tell you of any evasive actions to take to help yourself get back on course. You can use it to:
Plan Your Expenditure
Take care of the basics first. You can plan out both your contemporary and future expenditure for things such as inventory, maintenance, salaries, and so on based on your revenue.
Come Up With Strategies for Growth
Historical revenue data can aid in steering your long-term plans in terms of growth - how much you can invest in R&D, and how much you spend upgrading your property, plant, and equipment.
Examine Relevant Trends
With the help of historical data on revenue, you can measure and recognize the behavioral and buying patterns of customers and accordingly modify your operations around it.
Revamp Pricing Strategy
An accurate perception of revenue will also help you identify if the changes you are making are amounting to much or not.
Significance and Uses
Even though smaller businesses may view profit as their major point of consideration, the measurement of sales is just as crucial. It can deliver actionable data about the organization which cannot be gained from the measurement of profits alone. One can extract the maximum benefits out of the business information by recognizing the importance of revenue measurement.
Apart from the aforementioned, it also helps business owners in analyzing trends in sales over a certain period, equipping them with a better overall view of their business. A few of the apparent benefits of revenue tracking are the examination of daily sales trends to know if there has been any change in the pattern of customer behavior.
Moreover, business owners can use the data obtained from the monthly trends of sales revenue to strike a relationship between seasonality and sales volume. Further, the management can take appropriate measures to enhance the production or supplement the per-unit sales price based on this revenue trend to manage the sales volume accordingly.
The first metric on a statement of income, sales revenue is also the most important one. It signifies the point of origin for businesses to find out their net income, the basis for important business calculations and reports, including cash flow statements.
Apart from being the first metric on an income statement, sales revenue is also the most efficient metric for forecasting and historical analysis of data. That’s why its position at the top of the statement of income is significant. It’s because the figures that follow it are often expressed as a percentage of it. It also provides the best point of reference for forecasting the future of other figures on the income statement.