Businesses have to earn good revenue to remain competitive and pay for their operational expenses. They receive the revenue income in specific accounts called revenue accounts and maintain credit balances in them. Knowing about revenue accounts can help you with the management of your company’s revenues. In this article, we describe what revenue accounts are, how they work, the different types of revenue accounts and provide examples of revenue accounts.
What are revenue and revenue accounts?
Revenue is the money that an individual or a business earns from selling products or services to their customers. Revenue accounts are financial accounts that contain the receipts of the income or revenue that the individual or company receives through their business transactions. All income statements include revenue information, and it is a good indicator of how well the individual or business is doing on the commercial front. A high revenue turnover indicates business success, and a low revenue turnover typically means there are issues.
A business can earn a profit by increasing its income and lowering its production costs and other business expenses. The revenue can come from a single source or multiple business sources, and you can calculate it by adding together the price of a product or service and the number of units the company sells. All businesses try to increase their revenues by streamlining production to decrease costs, finding new customers and markets and using various marketing strategies to boost sales.
How revenue is classified
The classification of revenue in an income statement is as follows:
The total amount of money that a business makes by selling products or services is its gross revenue. So, if a company spends ₹50 on a product and sells it for ₹200, then ₹200 is its gross revenue. It is also known as gross sales. The gross revenue calculation can be at the end of a monthly reporting cycle or after an annual reporting cycle. So, the monthly gross revenue gives the total number of sales that the company generated in a specific month. The annual gross revenue is the total number of sales it generated in one year.
A company’s net revenue is the revenue that remains after deducting all its business expenses and the costs of goods sold from its gross revenue. The deductions can include employee salaries, material costs, equipment costs, product discounts and product returns. So, if a company has a gross revenue of ₹50,00,000 and spends ₹25,00,000 on running its business operations, its net revenue is ₹50,00,000 -₹25,00,000 = ₹25,00,000.
How does revenue work?
The revenue generation process includes the following elements:
When a business earns money by selling products or services, the revenue is known as top line. The term comes from the fact that the top line income appears at the top of the income statement. The reported top line revenue may be for a month, a quarter, a half year or a year. It is the total sales amount or gross revenue of the company before making deductions for operational costs. The top line is useful for measuring business growth and assessing the company’s ability to stay competitive in its specific market.
A company may calculate its revenue monthly, quarterly, half-yearly or yearly. It will add the number of sales it had in each period and report the income it earned in its financial statement for that period. The company may use the accrual accounting method or the cash accounting method to calculate its revenue. In the accrual accounting method, the company records its revenue when the transaction takes place, not when it receives money for the transaction. In the cash accounting method, the company records the income when it collects the transaction money.
The accounting method that a company selects has an impact on its income statement and balance sheet.
A balance sheet is a financial summary of all the business assets of a company or everything it owns. It also includes all the business liabilities of the company or everything it owes. It will also show the owner’s equity, which is the resulting amount after subtracting the liabilities from the assets.
Types of revenue accounts
An income statement can include the following types of revenues:
The revenue that a company earns from its principal business operations is its operating revenue. It generally forms a greater part of the company’s total income. Operating revenues for companies can vary according to their business type and industry. Some common examples of operating revenues are:
- Sales: When a business sells products or services to customers and receives money in exchange, it records the transaction as its sales revenue.
- Rents: When property owners rent out houses, apartments, buildings and land to tenants, the income they earn from the rental contract is their rental revenue.
- Professional services: When professionals in any field provide consultancy services to clients, the payments they receive for these services are the professional service revenues.
When a company earns an income from business activities aside from its main business operations, the income counts as a non-operating revenue. Such revenue includes the following:
- Interest revenue: The income that a business earns from investments, bank deposits and the repayments and interest from loaned money is known as interest revenue.
- Asset sales: When a company sells its assets and equipment, the one-time proceeds it gets from the sale are known as asset sales revenue.
Examples of revenue
The following are some examples of revenue:
- Government revenue: It is the revenue that the government collects from income taxes, property taxes, sales taxes, fines and penalties, securities sales, intergovernmental transfers, rental fees and corporate payroll contributions.
- Non-profit organization revenue: It is the revenue that comes from membership fees, individual donations, fundraiser collections, fees from hosted events, foundation grants and government grants.
- Real estate investment revenue: It is the revenue that a property generates from renting rooms, conference halls, banquet halls, wedding halls, facilities for recreation centres, shops, spaces for ATMs and parking spaces.
Revenue recognition methods
Businesses may collect revenue directly after delivering or providing products or services and submitting an invoice or based on the percentage of completion. To prevent businesses from changing what can qualify as revenue for their gains, regulators and analysts aim to standardise revenue recognition policies industry-wise. These can depend on how a business operates in a specific industry and under what circumstances. Some well-known revenue recognition methods applicable across business sectors are as follow:
Completed contract method
As per this accounting method, companies must report all the revenue they earn and the expenses they incur only after they complete the project contract. Companies generally adopt the completed contract method of revenue recognition if they are not sure about the exact completion date for the project and when they will get paid for the work. It is possible to postpone tax liabilities by postponing revenue recognition. However, that can also delay expense recognition and impair tax reduction. An example of a completed contract method is a construction project that can take two or more years to complete.
Cost recovery method
The cost recovery method involves recovering the total costs accrued by a business in creating the services or goods it sells to its customers. It will record the generated income and gross profit from the sales only after it has earned back the entire amount it spent. An example of the cost recovery method is when a company records its profit only after it has recovered the capital it used to finance its business operations.
In the installment method of revenue recognition, after a business makes a sale, the buyer pays for it with periodic payments spread out over a specified time given in the installment sales contract. The business can calculate the gross profit percentage of the total price and consider that it has received the entire gross profit only after the buyer has completed the total installment payments. Installment payment methods are for big purchases, such as machinery, consumer appliances, property and land, where buyers cannot pay the substantial amounts upfront.
Percentage of completion method
Businesses that undertake projects spanning over months or years use the percentage of completion method of revenue recognition. The companies can include the estimated costs, revenues and phases for work completed in the work contract and determine the completed work percentage. They have to report their revenues and expenses as the clients pay them for completed milestones on a phase-by-phase basis. This type of accounting method is usually in the construction industry where clients pay when the work starts, when it is partially complete and after it is over.
Revenue recognition happens at the time of the sale in the sales-basis method of accounting. It is common in businesses where the buyer pays upfront for goods or services and takes them away directly after payment. An example of a sales-basis method is when a customer walks into a shop, pays in cash for a purchase and takes it away.