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...
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 salculation
- Last year we sold 1,000 game consoles for $350 per piece.
- Sales revenue = 1,000 x 350 = $350,000
Why this simple calculation 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 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 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 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.