A company can generate different kinds of revenue, from product sales to rent income and franchise fees. Some businesses also receive revenue from royalties or interest. These earnings must be recorded in revenue accounts at the top line of your company's income statement. If you sell products or services on credit, you still need to record them as revenue, but the value is also recorded as accounts receivable.
TL;DR (Too Long; Didn't Read)
Businesses can make money by selling goods or services, renting space, charging royalty fees and more. These earnings need to be recorded in the company's revenue account before subtracting taxes, interest and operational expenses.
What Is a Revenue Account?
When you are a small business, it's relatively simple to track your revenue. You know exactly from where your money comes and your expenses. However, as your business grows, you may want to diversify your revenue streams. You may develop new products, expand your services, rent office space, charge royalty fees or earn revenue from lending money.
All of these earnings need to be accurately reported in your books, and that's where revenue accounts come in. This type of account shows a company's revenue from the sale of products or services as well as from side activities. As a startup or small business, it's essential to get positive revenue early.
A company's revenue accounts appear on the first line of its income statement. This amount can be determined by multiplying the price of goods or services by the number of units sold. For example, if you sell five smartphones at $350 each, your revenue is $1,750. How you record these earnings depends on the accounting methods used.
Generally, small-business owners use cash-basis accounting, which requires recording each transaction as soon as it takes place. When you sell a smartphone, you record those earnings in your revenue accounts. Accrual accounting, on the other hand, is more suitable for large companies and requires recording your earnings at the time of delivering a product or service, not when you receive the money. Therefore, you will record the sale as soon as you issue an invoice to a customer even if he doesn't pay right away.
Understanding Revenue Recognition
According to generally accepted accounting principles, a company's revenue is recognized under specific conditions. For example, you may use either cash-basis accounting or the accrual method to record your earnings. Therefore, revenue can be recognized over time or at a point in time, such as when you receive the money for the goods sold.
There are multiple ways a business can recognize its revenue depending on the industry and type of transaction. The completed-contract method, for example, is used to record the revenue and expenses associated with a project only after the project has been completed. With the sales-basis method, a company's revenue is recognized and can be recorded on its income statement at the time of sale. If a customer pays for your products over several years, you may use the installment method.
A clothing boutique, for instance, will most likely use the sales-basis method. A real estate developer, on the other hand, may use the installment method for revenue recognition. The percentage-of-completion method is typically used by construction companies. Choosing the right method for your business will ensure that you are not overstating or understanding your revenue and profits.
Types of Revenue Accounts
A company may have multiple revenue streams. These can be classified into two categories: operating and nonoperating revenues. Operating revenue comes from primary business activities, such as the sale of goods or services. Nonoperating revenue is what you earn from secondary business activities, including rent, interest, lawsuit proceeds and more.
If, say, you own a gym, your operating revenue comes from personal training services and the sale of memberships to customers, but you can also earn profits from investments or rent your gym to elite athletes who wish to train in private. These are examples of nonoperating revenue. Such earnings are typically stored in separate revenue accounts, including rental income, interest revenue, dividend revenue and more.
Your operating revenue will be recorded as sales revenue, rent revenue, service revenue and so on depending on your primary business activities. Digital marketing consultants, for example, provide services that help businesses expand their online presence, generate leads and reach more customers over the internet. Therefore, they will record their earnings as service revenue.
What Are Contra Revenue Accounts?
Your earnings must be recorded as a credit in your revenue accounts, but you may also have a sales discounts account or sales returns account that deducts money from your sales revenue. These are known as contra revenue accounts and have a debit balance.
Sales discounts accounts, for example, include the discounts offered to customers in exchange for early payments. If a customer returns the goods purchased, you must record their sales value in a sales returns account. Any allowances given against defective products need to be recorded in a sales allowances account.
Contra revenue accounts are listed under revenue accounts on a company's income statements. If, say, you have $10,000 in your revenue account and $3,000 in your sales returns account, then your net revenue is $7,000. This amount represents the income earned before paying rent, wages and other operational expenses. What you have left after deducting these expenses is your profit.
Revenue vs. Income
The terms "revenue" and "income" are often used interchangeably. While it's true that both refer to positive incoming cash flow, they are not the same.
Revenue is what you earn from the sale of goods or services. It doesn't include what you spend to produce those goods or offer those services. For example, a clothing boutique may spend thousands on rent, wages, shipping services and utilities each month. A digital marketing consultant may pay for office space, web hosting, website maintenance services and software programs.
Your net income, or net profit, is what you have left after you deduct your total expenses, taxes, interest and depreciation from your revenue. Your profit margin, on the other hand, is your income represented as a percentage of revenue. A company's earnings, or revenue, should be listed on the top line on its financial statement, while its income should be recorded on the bottom line.
The Importance of Revenue Accounts
A company's revenue accounts can tell a lot about its financial strength. Along with your net profit, revenue is one of the most important metrics you should track. Your revenue account can reveal important information about your business performance and profitability, sales trends, customer preferences and more.
Business owners can use their revenue and expense accounts to determine the cost of customer acquisition and how much each customer is worth. Furthermore, knowing how much you earn on average allows for more accurate financial forecasts. You may also use this data to identify patterns in customer purchase behavior, to see which products perform best and to project business growth.
Examine your revenue accounts every few months. Use this information to decide whether you should raise or decrease your prices, invest more in marketing or create new income streams. If you already have multiple streams of income, offer several types of goods or have branches in more than one city or state, consider hiring an accountant to keep track of your earnings and manage them more efficiently.
- Patriot Software: When Is Cash-Basis Accounting Acceptable?
- The Daily CPA: Revenue Recognition Methods of Long Term Contracts
- Investopedia: Revenue Recognition
- XPLAIND: Revenue Accounts
- Accounting Coach: What Is a Contra Revenue Account?
- EDUCBA: Revenue vs. Income
- Corporate Finance Institute: Revenue
Andra Picincu is a digital marketing consultant with over 10 years of experience. She works closely with small businesses and large organizations alike to help them grow and increase brand awareness. She holds a BA in Marketing and International Business and a BA in Psychology. Over the past decade, she has turned her passion for marketing and writing into a successful business with an international audience. Current and former clients include The HOTH, Bisnode Sverige, Nutracelle, CLICK - The Coffee Lover's Protein Drink, InstaCuppa, Marketgoo, GoHarvey, Internet Brands, and more. In her daily life, Ms. Picincu provides digital marketing consulting and copywriting services. Her goal is to help businesses understand and reach their target audience in new, creative ways.