What is the total revenue formula?

Revolut Contributor

 · July 28, 2020  · 07/28/2020

The total revenue formula is tricky to describe as it has more moving parts than seem apparent at first glance. So, before we look at how to calculate total revenue, we need to remind ourselves about how the whole concept works and then move onto the real-world challenges of when to record revenue.

For starters, the word revenue is often used to describe the sales turnover of a business or its total sales. There are nuances between the terms turnover and revenue, which we outline here. Even so, these terms are understood to mean the same thing, at least for the purpose of this post.

What is total revenue?

Revenue describes the income a business receives from selling its products or services, as opposed to income from its investments in other companies or a transaction unrelated to its everyday trading.

The business should describe those extra types of income as ‘other revenue’ or even ‘extraordinary revenue’. In practice, it’s not uncommon to blend all of these streams – but that’s another story.

At a basic level, the total revenue equation is when you multiply the number of units a business sells (or its number of customers) over a given period by the unit-price of these same goods or services.

Revenue = Number of units sold X Price per unit of good or service

This raw total is called gross revenue. Once the business deducts the total cost of promotional discounts or refunds, this reveals a more insightful figure called net revenue or net sales. The formula to do this is below, and we cover net revenue fully here.

Net Revenue = Gross Revenue – Discounts – Refunds

When income is not revenue

Technically speaking, revenue excludes sums that a business collects on behalf of third parties. Examples would be VAT on sales, or when a travel agency takes payment for a boutique hotel. If so, the agency should only record as revenue the commission it earns on this booking, not the total value of the transaction.

The big challenge with calculating revenue is to determine when a transaction should be formally recognised (i.e. recorded) in the business accounts, as this date can have significant implications. For instance, this will affect the period that the new revenue falls into and the resulting corporation tax bill.

If a business is registered to perform cash-based accounting, this date is whenever it receives the payment for the sale. A larger business must typically understand the revenue recognition principle, which we explore here. {RB31}

The rules on revenue recognition in the UK were changed in 2018 by the Financial Reporting Council in its IFRS15 guidelines. The premise is that recognition occurs when ownership of goods transfers to a customer for a mutually agreed sum. Here are the primary indicators of when ownership transfers:

  • Obligation to pay
  • Physical possession of the asset(s)
  • Legal title
  • Risks and rewards of ownership
  • Customer accepts the asset(s)

If a business invoices in advance for a service that it will perform over a whole year, it should not allocate the entire revenue to the month that it gets paid. The same is true of expenses. For instance, the business must smooth-out a quarterly rent payment across the three months this sum covers.

The five-step process to unlock the total revenue formula

With a complex sales transaction (e.g. the manufacture of a bespoke lathe with multiple prototypes) it can be more complex to determine when revenue must be recognised. The good news is that IFRS15 provides a new five-step process to cover most types of transaction. These five stages are shown below and explained in detail by ACCA (i.e. Association of Chartered Certified Accountants) here.

1. Identify the contract

2. Identify separate performance obligations

3. Determine the transaction price

4. Allocate the transaction price to performance obligations

5. Recognise revenue when each performance obligation is satisfied

There are scenarios when revenue recognition doesn’t happen at a specific moment and is said to occur over time. One aim of IRFS15 was to tighten-up the criteria for when the latter happens. The vendor business must now demonstrate, among other things, that it is creating an asset for which it has no alternative use. It must also have an enforceable right to payment for performance completed.

A good example of this is when a business refits a restaurant in a premises that is owned – or at least controlled by – the client. Another would be when a software developer creates a bespoke app for a client and can prove that it hosted this on the client’s servers during its entire gestation.

You can see that the total revenue formula can be either beguilingly simple or fiendishly complex, depending on how many pieces of the monkey puzzle you unpick. As ever, proper advice is prudent.

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