What is “Revenue”?
Revenue is the income generated by a company before deducting any expenses or costs incurred. Revenue is also known as the “top line” as it is usually the first line item in a company’s income statement. Other terms for revenue include sales and turnover. Revenue is a useful indicator of a company’s activities for a particular period, such as a 3 month quarter or a year. Revenue should not be confused with profit or net income (also known as the “bottom line”), which is the amount remaining after deducting all expenses from a company’s revenue.
Revenue can be of two types: 1) Operating revenue and 2) Non-operating revenue. Operating revenue is the income generated from a company’s core business operations which include the sales of goods and services. Non-operating revenue is one-time revenue, such as the proceeds from selling an asset such as an office building or factory.
Key Learning Points
- Revenue is the income a company generates from its sales for the period before deducting any costs incurred in generating that income
- Under the revenue recognition principle of accounting, revenue is only recognized when the product or service has been delivered. For projects that may take longer to complete, revenue can be recorded on a completion basis
- Revenue or the “top line” is the first line item reported in a company’s consolidated statement of operations, also known as the income statement
- Revenue can be classified into two types: operating, and non-operating
- The timing of recording revenue and receiving cash is not always the same. In businesses like retail, both events may happen at the same time. In other cases, companies may receive cash before (e.g. prepaid services) or after (e.g. postpaid services) it delivers a product or a service
Finding Revenue in Financial Statements
Revenue is reported in a company’s financial statements under the heading “Consolidated Statements of Operations”, also known as the income statement. Here is an excerpt from Cisco’s annual report 2019.
Cisco Inc. – Annual Report 2019
The company has reported its total revenue and its split of revenues generated through products and services. This information can be sourced in the management, discussion, and analysis (MD&A section) of the annual report.
Companies report their revenue split by products, services, and geographical location in their annual reports. In this example, out of total revenue of 51.9 billion, 39 billion (75%) is coming from product revenue and 12.9 billion (25%) from services revenue. If you look closely, the company’s product revenues are increasing at a faster rate (roughly 6% growth over the previous year) than its service revenues (roughly 2% growth).
Revenue Recognition Principle
Revenue recognition is an accounting principle, which provides guidance on when the sale of a product or service can be recognized in the accounting period. Under this principle, revenue is recognized in a business’s income statement when it is “earned”.
The principle helps companies decide in which year and how much they are allowed to record revenue. For example, if a business wins a tendering process, it is not allowed to record the revenue until it delivers the product or service. While winning the tender is beneficial for the firm, and potentially for its share price, the business has not yet delivered goods or services on that order; thus, revenues are not yet recorded.
The details about a company’s revenue recognition policies can be found in the company’s notes to financial statements. Some businesses are more straightforward than others, but many issues must be considered for revenue recognition, such as:
- Discounts and allowances
- Returns
- Selling expenses
- Timing of revenue recognition and
- Adjustments to any estimates made
A further and more detailed issue arises when the earning of the revenue takes significant time. Often, the risk is so substantial that the business will not undertake the activity until a contract has been signed with a customer. The following characteristics often apply:
- There is a contract with a customer before work starts
- The contract amount is a substantial portion of total revenue
- Work is likely to straddle financial reporting periods
In these cases, revenue is estimated on a “completion basis” with due regard for being prudent when making estimates.
Example: Revenue Recognition & Cash Impact
The recognition of revenues and the flow of cash are often at different times. We have been provided information about four different types of businesses and asked when the following firms would receive cash from their customers and when would they record revenue?
Cruise Line
A cruise line receives cash on booking, which could be several months before a cruise’s departure. However, it will record revenue only when the cruise occurs.
Retailer
For retailers, such as Walmart, the receipt of cash, and the recognition of revenue both happen simultaneously. When a product is sold, they receive cash and record revenues immediately.
Professional Football Club
A professional club such as Manchester United receives cash when season tickets are sold. However, it records revenue for each football match as it occurs.
Energy Company
Energy companies operate on a postpaid model. Revenues are recorded for each period based on consumers’ usage. The company receives cash at the end of the period.