Before we get to the formula for calculating revenue, let's make another revenue formula very clear:
Understanding revenue = understanding your business = growing your business
Revenue is the most fundamental metric for any company, and yet it is seldom understood perfectly. First, there is more than one type of revenue. Second, recording it and calculating it get progressively more complex as your business scales. And third, after you've calculated it, you must know what to do with it.
The future of your business starts with one simple equation.
What is revenue?
Before we get to the revenue formula itself, a definition: Revenue is the sum of all sales across a time period. Because this number often shows at the top of a company's income statement, it is called the “Top Line.”
It might be listed on that statement as revenue, sales, net revenue, or net sales. They all fundamentally mean the same thing, and they all stand for the most critical single figure in your company's accounting.
With that being said, not all revenues are equal. Literally. Being able to differentiate between types is vital, particularly with respect to net and gross revenue.
Net revenue vs. gross revenue
Misconceptions about net and gross revenue can significantly affect a company's income tax. Therefore, it's important to be able to distinguish between the two:
- Gross revenue concerns all income from a sale, with no consideration for any expenditures from any source. If a retailer sells the latest in a new line of sneakers for $100, the gross revenue would be $100.
- Net revenue subtracts the cost of goods sold from gross revenue. Fees for production, shipping, and storage, as well as any discounts, allowances, and returns, can all potentially contribute toward this cost. Net revenue from an item worth $100 that costs $25 to make would be $75.
Net revenue is often listed on an income statement at the bottom, hence the term "the bottom line.”
If your Top and Bottom lines already look like this, you may already be a master of revenue...
The revenue formula: how to calculate revenue
Now, let's take a look at the revenue formula itself. There are two principal variants of the revenue-calculation formula. Choose which to use based on whether your business is product or service-based:
- For a product-based business, the formula is
- Revenue = No. of Units Sold x Average Price.
- For service-based companies, the formula is
- Revenue = No. of Customers x Average Price of Services.
A sample sales-revenue calculation
- Last year we sold 1,000 game consoles for $350 per piece.
- Sales revenue = 1,000 x 350 = $350,000
Why the revenue formula causes so many problems
It seems so simple, but incorrectly calculating revenue has hurt many companies. Keeping track of revenue manually (e.g., using spreadsheet formulas or inputting the values by hand) can cause untold problems:
- Tracking revenue manually can quickly grow out of control. You must work out when you are entitled to payment for every subscription. Do you take it on billing? Do you take it incrementally over the course of a month of payment? Do you charge per unit of use?
- Every revenue-affecting change in your business needs to be accounted for. For example, if you alter a pricing page, underlying spreadsheets will have to be changed to account for this. Discounts, refunds, new pricing, and enterprise tiers can all complicate the amount of data that needs to be reconciled at the end of the year.
The stuff of which nightmares are made... (source: alltheshopsonline)
If you're a subscription business, revenue can be even more difficult to calculate. Now it's time for another round of “vs.”
Recognized revenue vs. deferred revenue
Recognized revenue is simple; it is recorded as soon as the business transaction is conducted. Once the sale has been completed, you can record it — all of it — in your revenue records.
A subscription-based company regularly receives payment for goods or services that they deliver in the future. As the company has received money in advance of earning it, this is known as deferred revenue. Therefore, this must be recorded not as actual income but as a current liability.
Let's say a company offers a video subscription service for $8.99 a month, totaling $107.88 per year. On receipt of a yearly subscription purchase from a new customer, the company cannot simply record the entire year's subscription. Each monthly payment is recorded as it is delivered to the company, before being reversed and booked as revenue at the end-of-year cycle.
Cash flow is not revenue, and treating them as the same thing could be fatal for your business. Bear the difference in mind when calculating and recording your revenue.
What to do with the data
Calculating revenue properly is the compass by which you can orient your entire company. It determines the possibilities you can pursue (or, alternatively, what drastic evasive action you need to take to get yourself back on track). Use it to help guide the direction of your company in a number of ways:
- Plan expenses
- The basics. Based on revenue you can plan both immediate and future expenses (inventory, pay for employees and suppliers).
- Determine growth strategies
- Historical revenue data can help guide your long-term plans for growth: how much you can invest in R&D, and how much you spend upgrading property, plant, and equipment.
- Analyze trends
- Historical revenue data also means you can identify customer behavioral patterns and adjust operations around it.
- Update pricing strategy
- A clear picture of your revenue will help you recognize if you are charging too little. Are you making enough profit vs. expenses?
Increase revenue by improving your pricing strategy
Nailing your pricing strategy is a great way to increase your company's revenue, and unlocking the data is key to first-rate pricing strategies. We can help you with that.
ProfitWell's Price Intelligently is an industry-standard pricing-strategy software that uses data to drive revenue. Our software and methodology combine our proprietary algorithms with a market panel. To that, we add a team of the best subscription and pricing economists in the space.
With it, your pricing strategy is revitalized by data and pricing becomes a core competency throughout your company. Moreover, your total revenues will soar.
ProfitWell's rigorous and precise revenue-recognition service, Recognized, is also an industry wave maker to keeping track of your revenue. Understanding revenue can take time — time that can be used vitally in other areas of growing your business. With our rigorous, precise solution helping you keep on top of that precious formula, you can strike the perfect balance.
How do you prevent loss of revenue?
Your SaaS company could be losing revenue through customer churn, failing to convert the right customers or poor monetization. Any of these mistakes mean you're missing out on potential revenue and hindering your company's growth.
Losing revenue through customer churn is the quickest way to turn your SaaS company into a leaky bucket that no amount of acquisition will be able to refill. You could be setting yourself up to lose revenue through customer churn if:
- Your product isn't engaging your customers: Customers who aren't using your product are very likely to churn—they won't want to keep paying for a service that isn't valuable to them. Your value proposition needs to be very clear to your customers, and you need to make sure you're constantly putting that value in front of them to help them be successful.
- You aren't communicating with your customers: Customer frustrations can be excellent sources of learning. Failing to listen to your customers' complaints means you're missing an opportunity to improve—and it means your unhappy customers will seek answers to their problems elsewhere.
You may also be losing potential revenue by failing to convert the right customers if:
- Your pricing page is confusing or uninformative: Your pricing page is the gatekeeper between your potential customers and conversion. The page should explain your plans clearly and make it easy for customers to make a decision and convert. A confusing page will discourage customers, and you'll watch potential revenue walk out the door.
- You try to incentivize conversion by offering discounts: Discounts may prompt some buyers to convert, but they're likely not the ideal customers that you want. Discounts erode your product's value, so the customers that convert just because you're offering a discount are less likely to see the value in your product. They'll likely have a lower Lifetime Value and may churn out sooner than the ideal customer.
Poor monetization can cause you to suffer huge revenue losses from existing customers if:
- Your pricing model isn't aligned along a value metric: Without a value metric, your customers won't feel that the prices they're paying are aligned with the value they're receiving from your product. These customers won't be able to get a version of your service that best meets their needs—a value metric would let you better monetize these customers by providing them with the exact version of your service they want to pay for.
- You haven't adjusted your prices in a long time: This means you're out of touch with your market's need and with their willingness to pay. Though you may have set your prices according to your market initially, demands change over time and your pricing strategy needs to adapt. You could be leaving money on the table by undercharging customers and undervaluing your product.
Read more about how to prevent mistakes that lead to revenue loss here.
How do you create a strong revenue growth strategy?
It can be discouraging to see slow, incremental revenue increases when you want to be showing investors exponential growth. This slow SaaS growth has been coined the Ramp of Death, because it feels like your company is never going to reach your revenue goals.
But even though it's tempting to think you should hit the pedal to the metal, incremental growth is the foundation of strong revenue.
Steady revenue growth over time corresponds with the graph of a line. The y-intercept and the slope of the line have real significance: they represent your defined point of initial traction and your revenue growth over time.
Creating a strong, incremental growth strategy means understanding and optimizing your starting point and your growth over time.
One component of this is defining when your linear growth begins and making a plan for long-term growth from that point. This defined start point is called initial traction—the company whose growth is shown in the graph above chose to define it at $100,000 MRR, when they felt they had reached their critical mass.
Understanding when your company has the means to start growing steadily helps you create a realistic plan for future growth. You can be confident that you have a viable company that will support constant growth in the long-term. You'll know where you're growing from, and set goals accordingly.
Don't obsess over when your start point is or how high it is—just understand what you define as your initial traction so you can make plans for your growth. Make decisions that will hold up in the long-term, and create a culture where employees can invest in the future of the company.
Another component of an incremental growth strategy is the rate of revenue growth over time. Growth comes from net new MRR each month, which is made up of new revenue from newly acquired customers and new revenue from current customers expanding their plans. Growth is slowed by MRR churn when customers downgrade or discontinue.
Knowing the slope of your growth shows you how your plans are playing out. You'll see how fast you're growing and whether your net new MRR each month supports steady growth. If you're not growing as fast as you'd like, you can then take steps to increase your net new MRR.
Increasing the rate of growth over time comes from balancing the factors that contribute to your MRR. Focus on retaining customers by delivering the value they were promised and constantly improving your product. Work to cross-sell and upgrade current customers so that the value they received increases over time, along with the revenue that they contribute.
Read more about the math behind slow, steady revenue growth here.