Revenue is one of the most fundamental figures for all businesses. It is the lifeblood that fuels growth, sustains operations, and ultimately determines success. Yet, for many, the concept of revenue can be confusing.
Revenue encompasses various sources and models, each playing significant roles in a company’s financial performance and health.
So, what exactly is revenue, and why is it so important?
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What Is Revenue?
Revenue is the total income generated from a company’s day-to-day operations, typically by selling a good or service. It is sometimes called the “top line” or “top line revenue” because it is the first figure on a company’s statement of profit or loss (income statement).
A company’s revenue depends on the total number of goods/services sold and the selling price per good/service. If a company sells 2,000 laptops for £800 each, its revenue would be £1.6 million (2,000 x 800).
Revenue vs Profit
Revenue and profit are sometimes confused since they are both used to represent what a company generates from its operations. But they are different in meaning and interpretation.
Revenue is the money generated from a company’s day-to-day operations before accounting for business expenses. It is the first and largest figure on a company’s statement of profit or loss (income statement) from which all business expenses are deducted.
On the other hand, profit (also called earnings) is the money generated from a company’s day-to-day operations after accounting for business expenses. Profit represents how much of the company’s revenue is left over after deducting all costs, as determined by this formula:
Profit = Total Revenue – Total Expenses
Assessing revenue and profit and the annual change in these figures gives investors a holistic view of a company’s financial performance.
Revenue vs Profit Example
Let’s say that in 2023, Example Industries sold 10,000 phones for £1,200 each. The company’s annual revenue would be £12 million (10,000 x 1,200). Assuming the manufacturing costs per phone were £800, Example Industries’ total expenses would be £8 million (10,000 x 800).
Following the profit formula, Example Industries’ profit for the year would be £4 million (£12 million – £8 million).
The £12 million in revenue reflects the amount generated by the company before accounting for business expenses. The £4 million profit represents the amount left over from revenue after deducting the £8 million in business expenses.
Types of Revenue
Revenue is classified as operating or non-operating based on how the company generates it. Grouping revenue into these categories gives investors insight into a company’s financial performance and long-term profit-generating ability.
Operating Revenue
Operating revenue is the total income generated from a company’s main business. For example, in an apparel company, all the money generated from selling clothing and related accessories is operating revenue. Operating revenue is the most important and sustainable revenue source, as it directly reflects the success of a company’s core operations.
Operating revenue is also recurring (predictable, stable and expected to be generated regularly).
Referring to the example above, revenue from selling clothing and related accessories is generated as long as the apparel company stays in business. Therefore, it is recurring – it can be counted on to be generated regularly with a relatively high degree of certainty.
Operating revenue is the same as a company’s top-line revenue – the total income generated from a company’s core operations.
Non-Operating Revenue
Non-operating revenue is any revenue not generated from a company’s core business.
In most companies, dividends received for investing in other entities would be non-operating revenue. Other examples of non-operating revenue include interest received for lending to other businesses (or the government) and income from selling a business asset.
Unlike operating revenue, non-operating revenue is non-recurring. It includes one-time or irregular sources of income, such as selling a business asset – it doesn’t happen often.
Due to their non-recurring nature, non-operating revenues are not included in a company’s top-line figure. They are either reported separately in a company’s statement of profit or loss (income statement) or grouped and presented in a single line item called ‘other income.’
Revenue Models
A revenue model defines how a company generates revenue from its core operations. Some revenue models include the following.
Transaction-Based Revenue Model
Transaction-based revenue, as the name suggests, is money earned from selling a good or service. This revenue model is simple, direct (occurring between a buyer and seller), and provides immediate cash flow.
An example of the transaction-based revenue model is buying groceries from a nearby store. Money is exchanged for the goods.
Subscription Revenue Model
Subscription revenue is earned from customers who subscribe to a service or a product. This type of revenue is generated regularly – monthly, quarterly or annually – and is used mainly by software companies.
An example of the subscription revenue model is paying a monthly fee for a streaming service.
Advertising Revenue Model
Advertising revenue is earned by allowing advertisers to promote products and services to an audience via various outlets, including websites, apps and social media platforms.
This revenue model can scale quickly with large audiences but is dependent on user engagement and susceptible to changes in advertising budgets.
Licensing Revenue Model
A company generates licensing revenue by allowing third-party entities to use its intellectual property (technologies, patents, brand name, business model) for a fee. This model lets companies earn passive income from their assets.
An example of the licensing revenue model is franchising, where a brand licenses its business model to franchisees for a fee.
Section Summary
A company may utilise one or several of these models to generate revenue. Despite being constricted to the type of good/service offered, the most successful companies find ways to implement several of these revenue models.
The more sources of income, the greater the company’s competitive advantage.
Why Revenue Matters
Revenue is crucial to all businesses because it gives insight into a company’s performance and directly impacts its overall success.
A few reasons why revenue matters are as follows.
Revenue is an indicator of financial performance.
Revenue is an essential indicator of a company’s financial performance. A trend of annual revenue growth shows that a company excels at retaining existing and attracting new customers, making sales, and generating increasing demand for its products. Growing revenues may also suggest a company can raise prices without serious customer pushback.
On the other hand, falling annual revenues may indicate internal problems, failure to innovate and keep up with competitors or inefficiencies in the business. Declining or stagnating revenues is not a good sign.
Growth, expansion and competitive advantages.
Revenue provides the necessary fuel for business growth. Companies with increasing annual revenues can reinvest more into new and existing products, expand into new markets and improve business operations. Once successfully done, these higher reinvestments can improve/fortify a company’s competitive advantages, thereby protecting its business and future revenues and profits.
Inadequate revenues and lacklustre revenue growth limit these opportunities and hinder a company’s long-term viability.
Valuation, business value and investor confidence.
Most valuation models link a company’s intrinsic value (what a company is worth) to revenue. Strong revenue growth forecasts lead to higher company values. Similarly, a robust revenue base can significantly increase the sale price of a company being bought.
Revenue is also a key figure investors assess when evaluating a company. Growing revenues indicate a sustainable business model and a potential promise of an adequate return on investment. Investors are often drawn to companies with high revenue growth.
Factors Affecting Revenue
Several factors impact a company’s revenue-generating ability, both positively and negatively. Some of these factors include the following.
Market demand and sales volume
Revenue depends highly on the demand for a company’s goods/services. If market demand is high, a company will sell more products (higher sales volume) and generate more revenue. On the contrary, if market demand is low, a company will sell fewer products and make less top-line revenue.
Competition
Competition also affects a company’s revenue. In highly competitive markets/industries, product selling prices can be driven down, negatively impacting revenue. To combat this, companies must increase their sales volume (sell more goods/services) to counter the lower prices.
Competitors may also offer superior products, services and pricing to lure customers away from other companies. This competition forces companies to innovate to differentiate themselves and continue growing revenue.
Seasonality
Some businesses experience revenue fluctuations based on the seasons. For example, retail companies generate more revenue during the Christmas holidays than at any other time in their financial year. Similarly, tourism companies often witness a spike in revenue during the summer.
Companies affected by seasonality often plan for slow periods and ensure they take full advantage of high-demand times.
Summary
In conclusion, revenue is the cornerstone of any business, providing a clear picture of a company’s financial performance. As the “top line” figure on the statement of profit or loss, it offers insight into the company’s ability to generate income from its core operations.
Understanding the different types of revenue (operating and non-operating) and recognising the importance of various revenue models can help investors assess a company’s ‘true’ financial performance.
Moreover, revenue growth is a fundamental indicator of a company’s ability to expand, innovate, and maintain a competitive advantage. It also plays a critical role in determining a company’s value.
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