Revenue is the first metric that appears on an income statement, and for good reason. It's the starting point for calculating profit, and generating enough of it means your business can cover operating expenses and stay afloat in the long run.
Yet, despite revenue's importance, there's a lot of confusion around it. What does (and doesn't) count as revenue? Is it the same as profit? And does it guarantee positive cash flow?
Let's get into the basics of revenue, how to calculate it, and how it differs from profit and cash flow.
What Is Revenue?
Revenue is the income a business generates through the sale of products or services during a fixed period of time.
When you think about your business’s revenue, you're probably thinking about a specific type: operating revenue. It's what a company produces from its primary income-generating activities, most likely sales.
There's also another type — non-operating revenue — which occurs outside of a business' primary operations. This type of revenue is infrequent and typically unusual, such as lawsuit proceeds or donations.
For example, a retail store generates its operating revenue through merchandise sales. However, the store may also generate revenue from a secondary, non-operating source, such as money awarded from litigation.
Is Revenue Profit?
While both revenue and profit are strong indicators of your business's financial performance, they are not the same — namely, in how they relate to expenses.
Revenue is your business' income before expenses, whereas profit is your business' income after expenses.
When we talk about expenses, this can include anything from inventory and operational costs to wages and taxes. Profit takes revenue and deducts any expenses from the same period. Ideally, after subtracting all your expenses you still have income remaining, making your business profitable.
What is the Revenue Formula?
Calculating revenue is a relatively straightforward process. Use one of the following formulas:
For product-based businesses, multiply the number of units sold in a statement period by the average price.
For service-based businesses, multiply the number of customers or contracts in a statement period by the average service price.
Does Revenue = Cash Flow?
If you're generating revenue, you're also generating cold hard cash — right? Many new business owners make this assumption, and it can be costly.
Businesses should never equate high revenue to positive cash flow. In fact, there may be times when your revenue is high, even while your cash flow is negative.
Here's an example: suppose your business sells a $5,000 forklift to a construction company on May 1st. Technically, you have $5,000 in revenue, but the construction company has until May 31st to pay the invoice.
Meanwhile, the cost to deliver the forklift is $500 —so your business has $500 in cash outflow before it can collect the $5,000 in revenue on May 31st.
Sometimes the exchange of products and services with cash isn’t simultaneous, which is why it's important to remember that high revenue means your products or services are selling well — not that your business is making liquid cash.
Revenue on the Income Statement: Top vs. Bottom Line
The top and bottom lines of your income statement are arguably the two most critical figures.
The top line is your company's gross revenue, which is the total sales your company brings in during a statement period. Therefore, when a company has "top-line growth," it sees an uptick in sales or revenues. That said, gross revenue isn't necessarily indicative of your ability to generate profit.
The bottom line is your company's net revenue, which is your gross revenue minus any expenses or allowances during the same statement period, including refunds and discounts. Of the two metrics, net revenue provides a more accurate picture of your company's income.
Let's look at an example income statement:
Gross revenue: $100,000
Total operating expenses: $21,000
Net revenue: $64,000
Both the top and bottom lines reveal important information about your company's financial health. The top line (gross revenue) measures how effective your company is at generating sales. The bottom line (net revenue) describes how your company's expenses and allowances are eating into the bottom line.
Revenue is the magic metric for assessing the financial health of your company. Since companies generally grow by increasing revenue, it's also a great indicator of future growth. But revenue is only the starting point — businesses must also consider how their expenses and operating costs are (or aren't) impacting their bottom line.
Originally published Dec 3, 2021 7:00:00 AM, updated December 03 2021