How Companies Calculate Revenue

Revenue is the amount of money a company receives in exchange for its goods and services. The revenue received by a company is usually listed on the first line of the income statement as revenue, sales, net sales, or net revenue.

Companies pay more attention to this single line item more than any other because it is the greatest factor that determines how their business is doing. There is a standard way that most companies calculate revenue.

Regardless of the method used, companies often report net revenue (which excludes things like discounts and refunds) instead of gross revenue. For example, If a company buys shoes for $60 and sells two of them for $100, and offers a 2% discount if the balance is paid in cash, the gross revenue that the company reports will be [2 x $100] = $200. The company's net revenue will be equal to [$200*0.98] = $196. The $196 is normally the amount found on the top line of the income statement.

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In a financial statement, there might be a line item called "other revenue." This revenue is money a company receives for activities that are not related to its original business. For example, if a clothing store sells some of its merchandise, that amount is listed under revenue. However, if the store rents a building or leases some machinery, the money received is filed under "other revenue." Companies account for revenue in their financial statements by either the cash or the accrual method.

There is a practice among companies to leave the "other revenue" line fairly slim in order to prop up the top line (net revenue) if it was a disappointing earnings quarter. This is true especially for companies that are heavily watched and traded, as the top line is the figure that is projected by investment sites, and is the number that is most commonly used to determine how a business is performing.

Revenue is very important when analyzing financial ratios like gross margin (revenue-cost of goods sold) or gross margin percentage (gross margin/revenue). This ratio is used to analyze how much a company has leftover after the cost of the merchandise is removed. (For related reading, check out Analyzing A Bank's Financial Statements.)

As you can imagine, companies can become almost artistic with how they handle their top line. For example, if they wanted to lower the cost of their merchandise so that their top line margins would appear larger, they could lease the merchandise or offer it at a premium. Using such a method would incur a higher net revenue than if they were to simply sell the product or service at its base cost.

Although the process for calculating a company's revenue seems rather straightforward, accountants can adjust the numbers in a legal way that makes it necessary for curious parties to dig deeper into the financial statements than just giving them a cursory glance. This is especially true for investors, who need to know not just a company's revenue, but what affects it quarter to quarter.