Revenue is one of the most fundamental figures in all businesses. It fuels growth, sustains operations, and determines company success. Yet, for many, the concept of revenue can be confusing.
So, what exactly is revenue, and why is it so important?
This is the third article in our Income Statement Series. Expand here for the others.
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 income statement.
A company’s revenue depends on two things:
- The total number of goods/services sold
- The selling price per good/service.
So, 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 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
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 total 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 deeper 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 because it reflects the sales from a company’s core operations. It is also recurring (predictable, stable and expected to be generated regularly).
Operating revenue is the same as a company’s top-line revenue.
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 companies would be non-operating revenue. Other examples 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. Due to this, non-operating revenues are not included in a company’s top-line figure. They are either reported separately in a company’s income statement or grouped and presented in a singular line item called ‘other income.’
Revenue Models
A revenue model defines how a company generates revenue from its core operations. Here are the main ones.
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.
Example: 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.
Example: 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 a combination of these models to generate revenue. Despite being constricted to the type of goods/services they sell, 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.
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 increasing the demand for its products. Growing revenue can also suggest that 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 are not a good sign.
Growth, Expansion & 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 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 & Investor Confidence
Most valuation models link a company’s intrinsic value (what a company is worth) to revenue growth. 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 projected revenue growth rates.
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 & Sales Volume
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
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 and differentiate themselves to continue growing revenue and stay in business.
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.
Rounding It All Up!
In conclusion, revenue is the cornerstone of any business, offering 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.
