Revenue is the value of all sales of goods and services recognized by a company in a period. Revenue (also referred to as Sales or Income) forms the beginning of a company’s income statement and is often considered the “Top Line” of a business. Expenses are deducted from a company’s revenue to arrive at its Profit or Net Income.
Revenue Recognition Principle
According to the revenue recognition principle in accounting, revenue is recorded when the benefits and risks of ownership have transferred from seller to buyer or when the delivery of services has been completed.
Notice that this definition doesn’t include anything about payment for goods/services actually being received. This is because companies often sell their products on credit to customers, meaning that they won’t receive payment until later.
When goods or services are sold on credit, they are recorded as revenue, but since cash payment is not received yet, the value is also recorded on the balance sheet as accounts receivable.
When cash payment is finally received later, there is no additional income recorded, but the cash balance goes up, and accounts receivable goes down.
Below is an example of Amazon’s 2017 income statement. Let’s take a closer look to understand how revenue works for a very large public company.
Amazon refers to its revenue as “sales,” which is equally as common as a term. It reports sales in two categories, products and services, which then combine to form total net sales.
In 2017, Amazon recorded $118.6 billion of product sales and $59.3 billion of service sales, for a grand total of $177.9 billion. The figure forms the top line of the income statement.
Beneath that are all operating expenses, which are deducted to arrive at Operating Income, also sometimes referred to as Earnings Before Interest and Taxes (EBIT).
Finally, interest and taxes are deducted to reach the bottom line of the income statement, $3.0 billion of net income.
The revenue formula may be simple or complicated, depending on the business. For product sales, it is calculated by taking the average price at which goods are sold and multiplying it by the total number of products sold. For service companies, it is calculated as the value of all service contracts, or by the number of customers multiplied by the average price of services.
Revenue = No. of Units Sold x Average Price
Revenue = No. of Customers x Average Price of Services
The formulas above can be significantly expanded to include more detail. For example, many companies will model their revenue forecast all the way down to the individual product level or individual customer level.
Below is an example of a company’s forecast based on many drivers, including:
Volume of different products
Return and refunds
As you can see in the example above, there is much more that can be included in a forecast other than just No. of Units x Average Price.
Revenue on the Income Statement (and other financials)
Sales are the lifeblood of a company, as it’s what allows the company to pay its employees, purchase inventory, pay suppliers, invest in research and development, build new property, plant, and equipment (PP&E), and be self-sustaining.
If a company doesn’t have sufficient revenue to cover the above items, it will need to use an existing cash balance on its balance sheet. The cash can come from financing, meaning that the company borrowed the money (in the case of debt), or raised it (in the case of equity).
In order to perform a comprehensive analysis of a business, it’s important to know how the three financial statements are linked and see how a company either uses its sales to fund the business or must turn to financing alternatives to fund the business.
Below, we will explore what the concept of revenue means in different sectors. As you will see, it can be composed of many different things and varies widely in terms of what the most common examples are, by sector.
Duties and tariffs
Sale of goods
Sales of services
The three main areas that typically make up the finance industry are public finance, personal finance, and corporate finance. As we demonstrated above, the various sources of income in each type can be quite different. While the above lists are not exhaustive, they do provide a general sense of the most common types of income you’ll encounter.
Thank you for reading CFI’s guide to Revenue. To help you advance your career, check out the additional CFI resources below: