In order to grow your business, revenue needs to exceed the costs of running your company. This may seem like a “Thank you Captain Obvious” concept. But the truth is, accurately calculating revenue to plan for future expenses and growth is not as cut and dried as you may think.That’s because there are different types of revenue, each one requiring a unique revenue formula to calculate. With these different formulas, you can approach revenue from multiple angles to get a full picture of your business’s finances. You aren’t just looking at total sales—you’re looking at sales in relation to business factors that impact your profits.
Three revenue formulas worth using are gross revenue, net revenue, and deferred revenue. To help you evaluate your company’s finances, we’ll break down what these three types of revenue mean, how to calculate them, and how to evaluate your figures.
Let’s get started.
Gross revenue: The simplest way to calculate sales
Gross revenue is one of the most common (and simplest) ways to calculate sales. It’s used to determine the total income generated from goods or services sold, period. That means gross revenue doesn’t take into account any of the expenses that go into selling a product.
Why gross revenue is important to consider
Simply put, gross revenue reflects your ability to sell a product. If your gross revenue is higher than that of your competitors, it’s a sign that there is greater market interest in your product.
But gross metric is a somewhat poor indicator of success. It doesn’t take costs into account, so it tells you nothing about a company’s profitability.
But for a newly established company, gross revenue is sometimes considered a measure of success. Startups are often operating at a loss for the first few years, so investors look to their gross revenue to evaluate demand for their products.
The gross revenue formula
To calculate gross revenue, just multiply the number of units sold by the cost of your product or service.
For example, if you sell 500 Xboxes priced at $249 each during the month of May, the gross revenue for that month is $124,500. Remember, the gross revenue formula does not reflect profit. It is, however, a necessary component in calculating it.
Net revenue: Accounting for cost to figure out profit
In order to calculate how much profit you’re making in sales, you have to deduct expenses from revenue.
That, in a nutshell, is net revenue. You subtract the cost of goods sold (COGS) from the gross revenue of a product. If you’re selling a product, COGS might include raw materials, product assembly, manufacturing overhead, and so forth. For software companies, COGS would likely be hosting fees or salaries for software developers.
Why net revenue is important to consider
Ignoring net revenue means ignoring the question of whether you’re profitable. If you start treating gross revenue like money in your pocket, you could end up spending more resources than you can make up in sales. As a result, you won’t be able to pay employees or the overhead expenses needed to keep a business running.
Track net revenue so you know the true profit made from a sale. Then, you can properly budget for future expenses and show potential stakeholders that your company does promise a return.
The net revenue formula
Calculating net revenue is simply subtracting COGS from gross revenue.
Consider the Xbox example referenced above. You sell 500 Xboxes in May priced at $249 each, totaling $124,500 in gross revenue. Additionally, it costs $200 to make a single Xbox, so the COGS for 500 units is $10,000. Subtract COGS from gross revenue, and you get $100,000 in net revenue. The net revenue formula should give you a better understanding of how your expenses and income balance each other out. Use it to identify any opportunities for reducing your COGS and improving profit.
Deferred revenue: Tracking prepayments separately
When companies receive payments for services they have not yet delivered, that’s called deferred revenue. Payments are considered “recognized” once delivery of services has been completed.
For example, let’s say you’re a B2B company that sells subscription-based software. You generally charge $10 a month, but many customers opt to pay by the year instead.
Customer A pays you $120 in full on January 1. At the end of January, you’ve successfully delivered one month of services, which means you can “recognize” $10 in revenue. The remaining $110 is considered deferred revenue until the end of February, at which point your deferred revenue is $100.
Why deferred revenue is important to consider
For subscription-based sales models, deferred revenue could make or break your business. That’s because it’s considered a liability, not income. There’s always the chance that you may not be able to deliver a service as promised. If that happens — and you’ve already spent that deferred revenue — you might not have the funds to pay back that customer.
You can also use deferred revenue to calculate the cost-effectiveness and the efficiency of your customer-acquisition strategies. Consider the subscription example above. If it takes $100 in marketing and sales to acquire a customer, it will take 12 months of $10 monthly subscription payments to gain those costs back. If you can reduce the time it takes to recover acquisition costs, your company will be able to turn a profit more quickly.
The deferred revenue formula
To calculate deferred revenue, add all payments for services and products that haven’t been delivered.
For example, if 10 customers pay $1,000 in advance for undelivered services, your deferred revenue is $10,000. Keep an eye on deferred revenue to make sure you’re not spending money that isn’t technically “in your pocket.”
Plan for sales growth by taking a holistic approach to revenue
To get a solid handle on your company’s finances, take a holistic approach to revenue. Use multiple formulas to analyze the bigger picture of how your company conducts business. With that informed perspective, you’ll be able to pull insights on how you can increase your profit margins and ultimately grow your company.