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MyWikiBiz, Author Your Legacy — Wednesday May 22, 2013
Revenue is a U.S. business term for the amount of money that a company earns from its activities in a given period, mostly from sales of products and/or services to customers. In Europe (including the UK) the term is turnover. For individuals, the equivalent term is income. For government, revenues refers to the gross proceeds received from taxes, fees, and the like. For non-profit organizations, revenue from products and services can be expanded to include proceeds from donations, grants, trade in lieu of cash, and other liquid assets.
Revenue is often referred to as the “top line” due to its position on the income statement at the very top. This is to be contrasted with the “bottom line” which denotes net income, revenues after all applicable costs. At times, the term “Sales” is used interchangeably, but is only accurate when the amount described is denoted in currency as opposed to units ($100,000 of iPod sales vs. 500 iPods sold).
Revenue is often simplified in economics or basic finance projections to “Price x Quantity” (the price of a good times the number of goods sold) though it is rarely this simple in actuality. Net revenue (revenue – returns) is used when sales returns are a factor in the business.
Revenue, like all income statement accounts, can only be presented in terms of a period, for example, the revenues a company earned between January 1, 2005 and December 31, 2005. Alternatively, one could express it in terms of the following examples: 2005 revenue, Q1 (1st quarter) revenue, or March revenue. This periodicity is in contrast to a balance sheet account, which would be given as of the date of the statement. To simply say that a company earned revenue of $5 million without giving a period is meaningless (however, saying that a company has $5 million cash certainly has meaning).
Revenue Recognition and Unearned Revenue
Conflicts abound as to when revenue should be recognized. The Financial Accounting Standards Board’s (FASB) Statement of Financial Accounting Concept 5 states that revenues should be recognized when they are “realized or realizable” and “earned”. Revenues are “realized or realizable” when products are exchanged for assets (such as cash) or claims to assets (such as promises to pay). Revenues are “earned” when the entity has performed all duties necessary to the purchaser.
Oftentimes one of the two situations will arise but not both. If assets are received before revenue is earned, a liability account is created called “Unearned Revenue”. An example of when this would happen is in the event of magazine subscriptions: suppose a company sold 12 month magazine subscriptions on July 1, 2005 for $10,000 cash. At the company’s year end, December 31, the company is still obligated to deliver 6 months, or $5,000, worth of magazines to subscribers. In this case, the company would recognize $5,000 as revenue for 2005, and $5,000 would be seen in the liability account “Unearned Revenue.”
In general, for US GAAP purposes, revenue should be recognized at time of delivery of the goods or performance of the service. If cash is received prior to this time, revenue is unearned as explained above. If cash has not yet been received at time of performance, the asset account “Accounts Receivable” will show this. This is in contrast to IRS revenue recognition policies, which call for revenues to be recognized on a “cash received” basis. In the above magazine example, the company would have to pay taxes on $10,000 of “revenue” for 2005.
Special Revenue Recognition Situations
There are several situations recognized by FASB wherein revenues should be recognized in ways different than described above. Construction companies, commodities producers, and sales with high rates of return are examples of these situations.
Revenue is a crucial part of any financial analysis. A company’s performance is measured to the extent to which its asset inflows (revenues) compare with its asset outflows (expenses). Net Income is the result of this equation, but revenue typically enjoys equal attention during a standard earnings call. If a company displays solid “top-line growth,” analysts could view the period’s performance as positive even if earnings growth, or “bottom-line growth” is stagnant. Conversely, high income growth would be tainted if a company failed to produce significant revenue growth. Consistent revenue growth, as well as income growth, is considered essential for a company's publicly traded stock to be attractive to investors.
Revenue is used as an indication of quality of earnings: if earnings are rapidly increasing without, and there are several financial ratios attached to it, the most important being Price / Sales, Gross Margin, and Net Income / Sales (profit margin). Also, companies use revenue to determine bad debt expense using the income statement method.
Price / Sales is sometimes used as a substitute for Price / Earnings when earnings are negative and the P/E is meaningless. Though a company may have negative earnings, it almost always has positive revenue.
Net Income / Sales, or Profit margin, is calculated by investors to determine how efficiently a company turns revenues into profits.