What Does Revenue Mean?
By Kyle Smith, CPA
Most directly put, revenue is “top-line” sales. However, technically for accounting and analysis purposes, revenue is equal to recognized cash inflows created by the sale of goods, products, or services in everyday business operations.
This second definition is more complicated and has more qualifiers. Still, it is also more helpful and relevant in making better business decisions. Therefore I’m going to break down this more technical definition to clarify the most important reason to analyze revenue: consistently measure results over time.
First, the issue of when revenue is recognized is vital for an apples-to-apples comparison.
For instance, suppose your biggest client pays you a set monthly fee. In the current month, however, two monthly payments are deposited on the 1st and 30th of the month (because of bank timing, the payment on the 30th hit the bank early).
Now, when you’re looking at operating results for the current month compared to the previous one, it appears you’re doing great and have 50% more sales due only to the monthly fee reflecting as revenue twice. In this case, it makes sense to accrue (basically move) the revenue stemming from the payment on the 30th to the subsequent month (how this is done is a separate topic), so you will now only see revenue recognized related to the current month to compare to prior AND future months. This is much more useful for bottom line Net Income comparisons, bonus calculations, gross profit analysis, KPI analysis, or anything else related to measuring the business’s success on a month-to-month basis.
Secondly, for financial analysis, it’s essential to look at revenue created from normal business operations.
This means any NON-recurring cash inflows, such as proceeds from a one-time grant, would be included “below the line” (below “Net Income from Operations” line on the Profit & Loss Statement (P&L)). Take this example of receiving a grant; if you include these proceeds at the top of the P&L along with revenue from normal operations, it will now skew all cost items below revenue (in terms of their percentage of revenue) and inflate the “Net Income from Operations” line.
Suppose you look at Gross Profit (GP) percentage as typically around 70% of Gross Revenue based on prior months. In that case, you may now get a false impression that you have done a better than average job at controlling direct costs this month when in reality, it is just the artificial boost from grant cash proceeds making GP percentage look better. Once again, all percentage cost and KPI analysis done in the current month will be an unfair comparison to both prior AND future months by showing non-recurring cash inflows at the top of the P&L, inhibiting your ability to make the best decision.
In sum, consistently measured revenue (by properly recognizing regular recurring revenue each month) is critical to showing apples-to-apples results each month, which is, in turn, vital for making the most profitable decisions.