Sales revenues / Revenues
Encyclopedia of Business Terms and Methods, ISBN 978-1-929500-10-9. Copyright © 2011 by Marty J.Schmidt. Revised 3 March 2012..
The Meaning of Sales Revenues and Related Terms
In private industry and commerce, revenues usually refrers to the sum of money owed or paid the company for sales of goods and services. The term sales revenues generally means the same thing, as well as the shorter form, simply sales. Financial accounting makes a distinction between net sales (revenues) and gross sales (revenues) as explained below. In Europe, The term turnover is sometimes used to mean sales revenues.
Like other income statement terms, revenues (sales revenues) usually refers to the sum of revenues across a specific period of time, such as a fiscal quarter or year. When reference is made to a company in terms of a single currency figure (e.g., "That's a $15 billion company," or "The firm has grown into a € 100 million company"), the figure represents annual sales revnues for the last reported year. Sales revenue figures are an important measure of a company's growth and financial performance, and the starting point for calculating many other important metrics, including gross profit, operating profiit, and net profit.
Note that in government usage, however, revenues refers to money flowing into or out of the government, from all sources, including taxes collected. In English speaking countries, the highest taxing authority for the national government, states, or provinces usually bears a name with "Revenue" included, such as "Inland Revenue" (UK, Ireland, New Zealand, Australia) "Internal Revenue (United States) or "Revenue Agency" (Canada).
• Gross Sales Revenues vs. Net Sales Revenues
• The Income Equation Begins with Net Sales Revenues
• Predicting and Measuring Sales Revenue Growth Rate
• Income Statement Example
• Three Kinds of Profit (Three Margins)
• Income and Financial Statement Metrics
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Gross Sales Revenues vs. Net Sales Revenues
In finance and accounting, Net sales revenues refers to the incoming revenues a company claims for selling goods and services in its normal line of business during an accounting reporting period (usually a quarter or year).
Net sales revenues, or simply Net Sales are distinguished from Gross sales revenues, which may also appear on the income statement. If, for instance, the company sells 100 units of an item having a list price of $10, Gross sales revenues are 100 x $10, or $1,000. Net Sales revenues, however, may be less: In reality, the company may not receive (or be owed) the full Gross sales figure:
- After purchase, customers may return goods for refund, thus reducing the net sales revenues.
- Customers may ask for an allowance, effectively a price reduction, for such things as minor defects found in the goods after purchase, thus reducing net sales revenues.
- Customers may be granted a discount, allowing them to purchase at prices below the list price, thus reducing net sales revenues.
In other words:
Net sales revenues = Gross sales revenues – returns, allowances, and discounts.
The role and the importance of net sales revenues in business planning and business analyses are more easily illustrated in the context of other terms, also related to income, as shown in the following sections.
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The Income Equation Begins with Net Sales Revenues
Net Income is sometimes referred to as the "bottom line" of the income statement. It is what remains after all costs and expenses have been subtracted from incoming revenues. If net income is the "bottom line," then net sales revenues have to be considered the income statement's "top line" (even if gross sales revenues actually sit above net sales revenues, as shown in the Example Income Statement below).
The income statement is a financial statement that reports a company's income for a period of time, usually for a fiscal quarter or fiscal year. Income is thus a measure of the company's earning performance for a specific period. The income statement heading will so indicate with a phrase such as
- ". . . for the year ended 31 December 2011," or
- ". . . for the quarter ended 31 June 2011."
This contrasts with the balance sheet, which shows the status of assets, liabilities and owner’s equities at one point in time.
The income statement generally shows how income figures result by subtracting the entity’s costs and expenses from its revenues.
Income = All Revenues – All expenses and costs
Note in the Example Income Statement and following sections below, there are several "profit" lines on the income statement (gross profit, operating profit, and net profit), and there can also be incoming revenue lines in addition to net sales revenues (such as revenues from financial income, or revenues from extraordinary items). However, analysts, investors, and company management look to the net sales revenue figures as the basis for calculating revenue growth, margins, and performance metrics such as "inventory turns" or "days sales outstanding."
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Predicting and Measuring Sales Revenue Growth
Potential investors who are considering buying shares of a company's stock, will consider carefully the company's ability to grow sales revenues and grow profits.
- Profit growth is important to investors because, in principle, profit making companies exist and operate primarily in order to create value for their owners (Shareholders). Companies do this by earning profits. Profits are either kept by the company as retained earnings (which increases shareholder value, or equity on the balance sheet), or, profits are distributed directly to share holders as dividends (a more immediate and direct way to increase shareholder value).
- Sales revenue growth is important to investors for several reasons.
- First, at least some sustained revenue growth is necessary to maintain or grow profits: inflation will increase the company's costs from year to year, and cost increases must be accompanied by revenue increases, even to maintain constant profits.
- Second, in a growing economy, a lack of growth in sales revenues probably means the company is not gaining market share over its competitors, and is not attracting new customers.
Predicting sales revenue growth is also important to the company's own management, for obvious reasons: the planning of next year's production, product development, inventory levels, marketing programs, hiring, and budgeting of all kinds, depend heavily on what the company expects in sales revenues.
One sales revenue metric that serves both investors and management in this regard, is the company's cumulative average growth rate (CAGR) in sales revenues. CAGR looks to a starting sales revenue figure (perhaps for Year 1) and a later sales revenue figure (perhaps for year 10), and asks: What is the average growth rate, per period?
If, for instance, sales revenues for Year 1 were 10 million, and sales revenues for year 10 were 100 million, what was the average growth rate per year? Remember that compound interest growth is involved. In the 9 years of growth, sales revenues increased ten-fold, to a level 1000% over the initial sales revenue figure. However, because of compounding, the average growth per year is not 1000% divided by 9. If that were the case, growth per year would have been 111% per year—but that is the wrong answer to the growth question.
For this example, the starting value (PV) is 10 million and the Final Value is 100 million. The number of compounding periods, n (years in this case), is 10 – 1, or 9. Using the CAGR formula:
CAGR = (100/10)1/9– 1.0 = 29.2% growth per year.
(For a more complete introduction to CAGR and other financial metrics, see Financial Metrics Pro).
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Income Statement Example
The income statement net sales revenue line is the "reference point" for calculating profits and margins, as shown in the example statement below.
The income statement is simply a detailed application of the income equation: Income = All Revenues – All expenses and costs. The example statement below might represent a manufacturing company, but the general form and major categories are typical for companies across a wide range of industries. A company that sells services rather than manufactured goods might report "Cost of services" rather than "Cost of goods sold," but aside from a few such minor differences in terms, the income statement structure is nearly universal.
Grande Corporation Gross sales revenues.................33,329 Gross profit.................................10,940 Operating expenses Operating income before taxes............... 3,130 Financial revenue & expenses Income before tax & extraordinary items..... 2,737 Extraordinary items Net Income (Profit).......................... 2,126 |
Notice that expenses fall into five major categories. The first three categories represent expenses that come from the company's normal business:
• Cost of Goods Sold
The costs of producing goods or services
• Operating Expenses – Selling Expenses
The costs of selling the goods or services
• Operating Expenses – General and Administrative Expenses
Overhead, support, and management costs from across the company
Note that depreciation expenses may appear in each of these categories, depending on what the assets in question are used for.
The remaining two major expense categories refer to both gains and losses from activities that are not in the company's normal line of business. This company is not, for instance, in the financial services, or financial investing, or lending business. The company is also not in the real estate business. Financial transactions in these latter areas must be reported separately from the areas that contribute to normal operating income.
• Financial Revenues and Expenses
These include revenues from invested funds and costs from financing
borrowed funds.
• Extraordinary Items
These may include large gains or losses from selling land or major assets,
or from major actions restructuring the company (e.g., the expenses of laying off
part of the workforce).
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Three Kinds of Profits (Three Margins)
Bottom line net income is a measure of the company's financial performance for the period, but the income statement contains other performance metrics as well. The difference between net sales revenues and cost of goods sold is called Gross profits, for instance, while the net income from operations—before taxes and before gains and losses from financial and extraordinary items—is called operating income (or operating profits).
All three of the profit lines from the income statement (gross profit, operating profit, and bottom line net profit) can also be expressed as a percentage of net sales, that is, as margins. Gross profit, for instance is gross profit divided by net sales (see the table below):
Margins, in turn, are very important indicators of a company's performance for stock market analysts, and for the company's own management.
- Analysts will compare the company's margin percentages directly with margins from competitors and with industry "best in class" standards. They will consider not only the current margins, but also period-to-period trends in margins.
- The company's management attention will focus on margins for several reasons:
- First, margins are central to the company's business model. Margin's in the model, that is, show exactly where the company expects to make money.
- Secondly, management will watch closely year-to-year changes in margins. Margins are a highly sensitive indicator of the company's ability to compete effectively and reach objectives in its business plan.
- Thirdly, Margins for individual product lines and even individual products are central to management planning and decision making in product portfolio management and other aspects of product planning. The income statement shows the gross margin, for instance, of the whole company, but underneath the company average gross margin (and shielded from competitors and public eyes), each product has its own gross margin as well. Only by knowing and managing the mix of individual product gross margins, can management optimize the overall product set gross margin.
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Income and Financial Statement Metrics
The term Financial Metrics refers to analyses performed on financial statement figures, as well as cash flow estimates in the business case and investment analysis. The word metrics means "measurement," and financial metrics—like descriptive statistics—reveal characteristics of a body of data that might not be appreciated easily simply by reviewing the data figures. Several of the major line items on the income statement provide further indicators of company performance, but contributing to commonly used Financial Statement metrics.
The financial statement metric (or "ratio") "Inventory Turns," for instance, is a measure of the company's ability to use assets efficiently and effectively. The metric is derived from an income statement term ("net sales") and a balance sheet term ("inventories"), and has meaning based on the idea that a company's assets should be working for the company and not sitting idle and unproductive.
Financial metrics based on financial statement figures are designed specifically to address questions like these:
- Is the company prepared to meet its short term financial obligations? Liquidity metrics such as current ratio address questions of that kind.
- Is the company using its resources efficiently?
Activity metrics such as inventory turns are designed for such questions. - Are the company's funds supplied primarily by owners or by creditors? Leverage metrics, such as debt to asset ratio provide answers.
- Is the company profitable? Is it making good use of its assets?
Profitability metrics such as the operating margin address such questions. - What are the company's prospects for future earnings?
Valuation metrics, e.g., price to earnings ratio deal with such questions. - How does the company's growth over the last five years compare to similar companies? To industry averages? Growth metrics such as the cumulative average growth rate (CAGR) for sales
revenues are useful for such questions.
Many of the input data items for these metrics come from the income statement. For a complete coverage of financial metrics, and of the interrelationships between income statement and balance sheet, and other financial statements, see the Solution Matrix Ltd. spreadsheet-based tool, Financial Metrics Pro.
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