One goal that all for-profit business owners have in common is to grow and sustain revenues. In general, the higher the revenues, the more money that ends up in their pockets.
While revenue is not a tough concept to grasp, growing it isn’t always an easy feat. Business owners should have a solid understanding of what revenues consist of, how it differs from income or profits, and the various factors that could influence the amount of money the business earns. In this article, we’ll touch on each of these points in further detail.
Revenue definition
Revenue is the total amount of money a business earns during a given period. This value consists of all sales, profit from investments, and any other amount produced by normal business operations.
Revenue may be referred to as the “top line,” referencing where it’s reported on a business’s profit and loss statement (also called the income statement).
Importance of revenue for businesses
Revenue is the lifeblood of a business. It’s how the company is able to generate funds to support operations, invest in growth initiatives, pay employees, and distribute profits to owners, investors, and creditors.
Businesses can survive without revenue during the initial startup phase when operations are funded by the owner’s capital, investors, or loans. However, at a certain point, the business needs to attract customers and make sales to become self-sufficient and support ongoing operations.
Revenue vs sales
While the two terms are often used interchangeably, there are certain instances where revenue and sales could refer to different values.
Sales occur when the company exchanges goods or services for money. Other common business terms under this umbrella include gross sales, which refer to the total amount generated from selling products or services, and net sales, which are the gross sales minus the cost of goods sold (COGS).
Revenue may refer to other sources of incoming funds aside from sales activities, which is why the two could be distinguished from one another. However, it is common to use one or the other when referring to the top line.
Revenue vs profit/income
Profit and income are other terms commonly associated with revenues. Both refer to the portion of revenue that a company gets to keep after accounting for expenses.
The profit/income is found by subtracting things like the cost of goods sold, selling, general and administrative expenses, depreciation, interest, taxes, and more from the total sales amount.
A company’s profits will always be lower than the revenue. Thus, aside from having a goal to generate more revenue, companies may also focus on optimizing profits and reducing expenses to retain more of the sales they earn.
Calculating Revenue
Revenue formula
Revenue can be calculated in a few ways, depending on the various sources of income a business has. The most basic formula is as follows:
This is the formula for sales, representing the total amount of money a business makes for the products or services it sells.
However, if the business has other ways of generating income, like rent payments, interest payments, dividends, etc., the formula simply adds up the total money that comes from each income source.
Example of revenue
Let’s say there’s a local flower shop that sells small, medium, and large flower arrangements, which are priced as the following:
- $25 for small arrangements
- $45 for medium arrangements
- $65 for large arrangements
During one week, they sell 27 small arrangements, 18 medium arrangements, and 12 large arrangements. To find the total revenue for the week, we’d need to make the following calculations:
- $25 * 27 arrangements = $675
- $45 * 18 arrangements = $810
- $65 * 12 arrangements = $780
Adding each of these sales values together, we get the total weekly revenue for the flower shop:
- $675 + $810 + $780 = $2,265
Methods for tracking and analyzing revenue
There are a few ways for businesses to track and record revenue, depending on the accounting method they follow. This may impact the amount of revenues reported in the income statement at the end of the period based on factors like the timing of payments and when the company delivers goods and services that customers have purchased.
Many businesses use accrual accounting, per GAAP standards. Companies using this method follow the revenue recognition principle, meaning they record revenues when the sale is made, even if they have yet to receive the payment for it.
Thus, under accrual-based accounting, sales made on credit and recorded under account receivables would still be included in the revenue value on the income statement. When the company eventually receives the payment from the customer, there is no impact on total sales.
Conversely, cash accounting follows the actual inflows and outflows of cash. Using this method, the company only records a sale when they receive the payment from the customer. So, customers simply placing an order has no effect on revenue if it’s made on credit.
There are pros and cons to using either method, and companies typically have a choice between which they follow. However, once they choose a method, they must use it consistently to avoid reporting errors or compliance issues.
Key factors affecting revenue
The amount of revenue a company generates hinges on several key factors, such as:
Pricing
The price of a business’s goods and services can directly influence the amount of revenue it earns. All things considered equal, a company could earn more revenue by charging $12.50 for a given item compared to $10.
There is a delicate balance between setting prices high enough to support operations without alienating potential customers with a price point that’s too out of reach — or not backed up by the value of the offering.
Marketing strategy
Sales and marketing efforts also influence revenues. A company that doesn’t promote itself effectively may not generate customer interest, hampering sales activity.
The business can have an exceptional product or service. But, if customers are unaware that it exists or are unfamiliar with the new company, this could be reflected by lower revenue.
Economic trends
Other factors outside of the company’s control may impact sales performance. For instance, macroeconomic trends like unemployment or inflation may influence consumers’ ability or willingness to spend on certain goods or services, affecting how much revenue the company brings in during certain periods.
The good news is that the economic landscape is constantly in flux. So, even if the current environment is not ideal, the conditions are bound to improve at some point in the following months or years.
Seasonality
Certain businesses experience seasonal demand, which will impact their revenue throughout the year. These trends are largely unavoidable and something businesses should be aware of to make smart workforce planning and purchasing decisions throughout the year.
A landscaping business, for instance, likely makes a majority of its yearly revenue during the spring and summer months, while things slow down in the fall and winter.
Consumer preferences
Consumer demand for certain products and services also drives revenue results for businesses. Some offerings are evergreen and have been in demand for decades, while others have temporary demand and could become obsolete as market dynamics and consumer preferences change over time.
As certain items or services fall out of favor with the average consumer, the companies providing such offerings could experience a drop in sales.
Supply chain issues
A company’s ability to earn revenue directly relies on its supply chain. If the company does not have a reliable supplier for inventory, input parts for manufacturing, or other necessary components to deliver products and services, its revenue could suffer in return.
Effective strategies for maximizing revenue
Companies have several levers available to improve sales performance and bring in more revenue.
Optimize pricing
One option is to assess the current pricing strategy and determine if lowering or raising prices could make a meaningful difference in total revenue.
Again, raising prices to a certain degree to keep pace with inflation and properly reflect the value offered can be a solid way to drive revenue growth. However, companies need to avoid raising prices too high, which impacts consumer demand for the product and results in fewer sales.
Maybe service-based businesses can add new pricing tiers to attract a whole new segment of customers. Product-based businesses can assess competitor pricing strategies to determine where they sit in the market and what customers for similar goods are willing to pay.
Conduct thorough market research
Businesses should also evaluate their product or service offerings and determine whether there’s ample market opportunity to drive sustained revenue growth.
It’s certainly possible to operate a sustainable business in a mature market. However, it’s worth assessing if the business has the right product-market fit or whether it needs to pivot, adjust its offerings, or enter a new market.
Owners might meet with internal marketing teams or external consultants to determine if they’re targeting the right customers or solving a specific problem their audience has.
Engage in promotional activities
If companies need to increase sales in the short term, it may be wise to engage in a promotional strategy.
Sales and promotions should be used wisely, and they aren’t a sustainable way to increase revenue over the long run. However, they can be highly effective and motivate customers to buy.
Offers like buy-one-get-one sales, discounts, free shipping, or free gifts can help encourage sales activity among customers who otherwise would not have made a purchase. As a reminder, promotions may increase revenue but could decrease profits temporarily as you sell goods on a lower margin.
Utilizing technology to manage incoming payments
No matter if you’re just starting out or a long-standing business, implementing digital tools to automate accounts receivable management can help you streamline operations and receive payments for accrued revenue faster.
Platforms like BILL allow you to use the convenient auto-charge feature to ensure you receive the money you’re owed, and easily manage outgoing invoices in one place.
Sign up for your risk-free trial of BILL today to see how the platform can help you automate invoicing for quicker payments.
