Every business’s goal is to make money. And what is Revenue? A business will sell a good or service and receive compensation, that is Revenue.
It’s an oldie but goody, but let’s focus on a lemonade stand as a business. This example is used often, but I love using this example because it is how I teach my children. My kids LOVE doing lemonade stands in the summer. Almost every week my kids will make up a batch, set up their table, and start screaming “LEMONADE” throughout the neighborhood. Gotta have Marketing too right?
What they learn; they receive money by selling products and dealing with customers. That is how we define sales or Revenue. That is how a business makes money.
What is Revenue?
We can define Revenue as: “The total sales that come from the transaction of goods and services before expenses are paid out.”
Revenue can also be referred to as, gross sales or top-line sales. We’ll discuss the Income Statement later, but Revenue is always listed at the very top of this report. As stated in the definition, this is the sales BEFORE expenses are calculated.
Looking back at our lemonade stand, if every cup of lemonade is sold for $1, and my kids sell 10 cups, their revenue is $10. The expenses in this case would be the supplies needed to sell the lemonade: cups, lemons, sugar, mix, etc. but for my kids, we focus on that initial sale, the Revenue. We’ll layer in the more complex topics like “Dad Tax” later.
Where to Find Revenue?
This is probably one of the easiest metrics to find when it comes to investing. Depending on the website or research site you are looking at, Revenue could be reported in several places. My preferred source to find Revenue is the Income Statement.
The Income Statement is just one of three financial reports. The other two are the Balance Sheet and Cash Flow Statement. These three reports are good at analyzing aspects of a business, but we will focus on them as more advanced topics. If you want to find out more about Income Statements, this article does a good job breaking it down.
As referenced earlier, Revenue can also be called top-line sales or net/gross sales. Looking at the example below, Revenue is called this because it’s at the very top, the first line of the report. A pure metric, no adjustments, additions, or subtractions; how much money was exchanged due to the actions of the business.
Why is Revenue Important?
It might seem pretty obvious that Revenue is important. Cause and effect, right? Do something, sell something, and get something in return. But that amount you get back in return can vary wildly due to many factors.
I briefly mentioned it earlier, but if Revenue is top-line sales before expenses, then the Revenue needs to be greater than expenses to make money. We can illustrate this with our lemonade stand.
“Revenue needs to be greater than Expenses”
If each cup of lemonade my kids sold was $1 (our Revenue) there was a reason to set that price (well and a $1 bill looks a lot cooler to an 8-year-old than a couple of quarters.) We need to determine how much money it costs to make that one cup of lemonade. If we factor in our lemons, sugar, cups, pitcher, and the stand itself, say it takes $0.40 to make one cup. Our Revenue minus expenses equal net income, how much money we took home. In this case, we made $0.60 per cup.
The point is, the income a business makes is dictated by the Revenue and expenses. Revenue has to be greater than expenses. This is true for every business.
Real World Examples
When analyzing a business, it is important to understand what goods or services they provide, because that will dictate its Revenue. We talked about our lemonade stand, but how about a real company (don’t tell my kids their lemonade stand isn’t a real company.)
Let’s look at a Ford F150. In this example, the base model’s price is around $35,000. If the truck was sold for this much (ignoring discounts/deals/etc.), that would be their Revenue. The reason why that price is so high is due to all the materials, machinery, factories, technology, people, etc. it takes to make a truck.
Now let’s compare it to another company, 3M. 3M makes household items like tape, wall hooks, command strips, etc. If you wanted to purchase a 3-pack of medium-sized wall hooks, it would cost $10. The expenses around building plastic wall hooks are far less than a pickup truck.
Understanding the expenses of a business will help determine its Revenue of a business.
How to Grow Revenue
Now that we know how expenses can dictate Revenue, how can a business grow its Revenue?
There are two ways of growing Revenue for a Business:
- Do more.
- Raise Prices.
Going back to our lemonade stand, the first way to increase Revenue is to “do more”, which in this case is selling more cups of lemonade. Say my kids sell 10 cups one day, so they make $10. But the next day it is hotter outside and they sell 20 cups, which doubles their sales. My kids could also “Do More” by adding more products to sell in their business, like cookies. Do more, sell more, and grow Revenue.
Another option my kids have available is to raise their prices. Instead of charging $1, they could charge $2. This is a double-edged sword because you might make more per sale, but you might make fewer sales. There are certain circumstances that this might make sense.
These two techniques can work for any business model.
Summary
Remember, Revenue comes from the initial transaction of providing service and/or selling goods before expenses are paid out. Without Revenue, a company cannot make money and will not survive.
Revenue can be found on one of the three financial reports, the Income Statement. It can be found on the top of this report.
Lastly, Revenue is the lifeblood of a company. It is needed to be able to pay for the expenses of the business to operate. As investors, it’s important to invest in companies that are growing that Revenue. Revenue growth can come from two different ways; do more – sell more and/or increase prices of the goods or services.
Good investors should understand the business that they want to invest in, and how their company makes money.
Disclaimer
Levelzeroinvestor.com is not a registered investment, legal or tax advisor or a broker/dealer. All investments / financial opinions expressed by Levelzeroinvestor.com are from the personal research and experience of the owner of the site and are intended as educational material. Although best efforts are made to ensure that all information is accurate and up to date, occasionally unintended errors and misprints may occur.
