How Companies Calculate Revenue

Revenue is the amount of money a company receives in exchange for its goods and services or, conversely, what a customer pays a company for its goods or services. The revenue received by a company is usually listed on the first line of the income statement as revenue, sales, net sales, or net revenue.

Aside from the bottom line (net income), companies pay more attention to this single line item than any other. It is the greatest factor that determines how their business is doing. It tells a company clearly how much money it is bringing in from the sale of its product.

Changes in revenue can be analyzed to determine if marketing strategies are working, how price changes affect the demand for the product, and a multitude of other insights.

Key Takeaways

• Revenue is another word for the amount of money a company generates from its sales.
• Revenue is most simply calculated as the number of units sold multiplied by the selling price.
• Because revenues do not account for costs or expenses, a company’s profits, or bottom line, will be lower than its revenue.

How To Calculate Revenue

There is a standard way that most companies calculate revenue. Regardless of the method used, companies often report net revenue (which excludes things like discounts and refunds) instead of gross revenue.

For example, a company buys pairs of shoes for $60 and sells each pair for $100. They offer a 2% discount if the customer pays with cash. If the company sells two pairs of shoes to a customer who pays with cash, then the gross revenue reported by the company will be $200 ($100 × 2 pairs). However, the company’s net revenue must account for the discount, so the net revenue reported by the company is $196 ($200 × 98%). This $196 is the amount that would normally be found on the top line of the income statement.

The most simple formula for calculating revenue is:

• Number of units sold × average price

Also:

• Number of customers × average price per unit provided

Expenses and other deductions are subtracted from a company’s revenue to arrive at net income.

Other Revenue

In a financial statement, there might be a line item called “other revenue.” This revenue is money a company earns or receives for activities that are not related to its original business. For example, if a clothing store sells some of its merchandise, that amount is listed under revenue. However, if the store rents a building or leases some machinery, the money received from this business activity is filed under “other revenue.”

Recording Revenue

Revenue is recorded on a company’s financial statements when it is earned, which might not always align with when cash changes hands. For example, some companies allow customers to buy goods and services on credit, which means they will receive the goods or services now but will pay the company at a later date.

In this case, the company will record the revenue on the income statement and create an “accounts receivable” account on the balance sheet. Then, when the customer pays, the accounts receivable account is decreased; revenue is not increased because it was already recorded when it was earned (not when the payment was received).

What Revenue Reporting Is Used for

Revenue is very important when analyzing gross margin (revenue minus cost of goods sold) or financial ratios like gross margin percentage (gross margin divided by revenue). This ratio is used to analyze how much profit a company has made after the cost of the merchandise is removed but before accounting for other expenses.

As you can imagine, companies can become almost artistic with how they handle their top line. For example, if they wanted to lower the cost of their merchandise so that their top-line margins would appear larger, they could lease the merchandise or offer it at a premium. Using such a method would incur a higher net revenue than if they were to simply sell the product or service at its base cost.

What’s the Difference Between Gross Revenue and Net Revenue?

The difference between gross revenue and net revenue is:

• When gross revenue (also known as gross sales) is recorded, all income from a sale is accounted for on the income statement without consideration for any expenditures from any source.
• When net revenue (or net sales) is recorded, any discounts or allowances are subtracted from gross revenue. Net revenue is usually reported when a commission needs to be recognized, when a supplier receives some of the sales revenue, or when one party provides customers for another party.

How Do Businesses Report Revenue on Their Tax Returns?

Businesses report revenue on their tax returns by listing all sources of income—including sales, investments, and other revenue streams—and then subtracting allowable business expenses to arrive at taxable income.

Corporations use Form 1120, including Form 1120 for C corps and Form 1120-S for S corps, to file tax returns. Sole proprietorships and single-member limited liability companies (LLCs) use Schedule C (Form 1040). Partnerships and multiple-member LLCs use Form 1065.

What’s the Largest Company in Terms of Revenue?

The largest company in the world ranked by revenue is Walmart (WMT). The largest non-U.S. company ranked by revenue is Saudi Aramco.

The Bottom Line

The process of calculating a company’s revenue is rather straightforward. However, accountants can adjust the numbers in a legal way that makes it necessary for curious parties to dig deeper into the financial statements to get a better understanding of revenue generation than just looking at a cursory figure. This is especially true for investors, who need to know not just a company’s revenue, but what affects it from quarter to quarter.