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Next Read: What is Gross Profit?
Total revenue refers to the money your business generates from selling its goods or services during a given period. It’s one of the most important line items on the income statement and critical to many other financial metrics and formulas.
Here’s what you need to know about total revenue, including how to calculate it, why it matters, and how to increase it.
Total revenue is the first line item on the income statement, so it doesn’t have a formula involving other line items like many other financial metrics. Instead, you’ll need raw financial data to calculate it, including the price of your products or services and your total sales volume.
Here’s the simplest way to express total revenue as a formula:
Total Revenue = (Units Sold x Price of Units) – Allowances – Discounts – Refunds
Total revenue is a straightforward calculation for most small businesses, but it’s essential that you get it right. Let’s go over a quick example to demonstrate how it would work in practice.
Say you have a business that sells custom shirts. In the first quarter of 2020, you sell 600 t-shirts for $20 each and 500 long-sleeve shirts for $30 each.
You don’t have any allowances during the period since they’re relatively uncommon. However, you sold 100 of your t-shirts to a family friend at a 25% discount, and one of your other clients returned 50 long-sleeve shirts.
Given that information, here’s how you’d calculate your total revenue for the quarter: [(600 t-shirts x $20) + (500 long-sleeve shirts x $30)] – (100 t-shirts x $20 x 25%) – (50 long-sleeve shirts x $30) = Total Revenue
When you simplify that, here’s what you’d get: $12,000 t-shirt sales + $15,000 long-sleeve shirt sales – $500 discounts – $1,500 returns = $25,000 total revenue.
Revenue refers to the money your business generates before accounting for any expenses. Meanwhile, profit refers to the money your business retains after paying for the various costs it incurs.
The three primary types of profit include gross, operating, and net profit. Here are the formulas for each of them:
Gross Profit = Total Revenue – Cost of Goods Sold (COGS)
Operating Profit = Total Revenue – COGS – Operating Expenses
Net Profit = Total Revenue – COGS – Operating Expenses – Other Expenses
Cost of goods sold refers to the expenses necessary to make your products or services ready for sale, such as direct labor and direct materials. Operating expenses are the expenses you incur in your day-to-day business activities, like rent and marketing. Finally, other expenses include those that aren’t directly related to your primary business operations, such as interest and income taxes.
Because profit accounts depict your earnings after deducting these expenses, they’re generally more accurate profitability measures than total revenue.
Total revenue might not say much about your profitability by itself, but it’s still a critical line item that’s involved in calculating many other important financial metrics. For example, here are some formulas for the metrics you can calculate with total revenue:
Not only does analyzing your financial performance with these metrics help you determine whether you’re on track to reach your goals, but it also helps you make better-informed business decisions and achieve them more quickly.
Total revenue is the primary driver of your business’s financial success. Having a healthy and stable revenue is essential for paying the expenses necessary to maintain your business operations, such as your rent, employee wages, and production costs.
Growing your total revenues also gives you the opportunity to use the excess funds you generate to make strategic business investments and scale your operation. For example, it can help you purchase additional equipment, expand your sales team, or increase your marketing efforts.
Ultimately, your business won’t be able to survive without sufficient revenues, let alone reach your long-term growth targets.
Total revenue is mainly a function of the price of your goods and services and the number of units you sell. As a result, the two primary ways to increase this line item are to raise your prices or sell more of your offering.
Raising your prices can be a highly lucrative strategy because it doesn’t cost you anything. In some industries, it can also improve the perception of your offering’s quality, simultaneously increasing demand. However, raise them too much or too quickly, and you risk driving away customers, which can outweigh any benefits you might see.
Conversely, selling more units tends to cost money. Whether it requires you to increase your marketing budget or expand your sales team, you usually have to pay to get results. However, there’s no limit to the potential upside and no risk of offending your customers.
You must perform financial and market analysis to determine the right approach for your circumstances, which may involve leveraging both tactics.
Nick Gallo is a Certified Public Accountant and content marketer for the financial industry. He has been an auditor of international companies and a tax strategist for real estate investors. He now writes articles on personal and corporate finance, accounting and tax matters, and entrepreneurship.
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