How To Calculate Revenue In Accounting
Revenue is a company’s income from its various operation sources. It is a monetary measure, and it is generated from sales that exceed the cost of goods sold. In accounting, revenue can be calculated in two ways: it can be calculated by using the top line or by using the bottom line. The top-line method calculates revenue by adding gross profit and subtracting expenses incurred to make and sell products or services. The bottom line method calculates revenue by taking net income where all revenues have been deducted from costs for operating expenses, interest expenses (as well as other deductions). This article discusses how to calculate revenue in accounting with the formula:
Gross margin or gross profit is the difference between takings and the cost of a product or services minus the cost of goods sold. It helps ascertain whether a company is operating at a profit or loss. Gross margin determines if an organization has a competitive advantage over its competitors.
Gross margin or gross profit can be calculated by taking the difference between revenue and cost of goods sold.
Gross Profit = Revenue – Cost of Goods Sold.
The cost of goods sold is the cost incurred in producing a product, including direct labor, direct material expenses, and other manufacturing costs. It also comprises indirect fixed costs such as rent, depreciation, and insurance. The cost price of a product is an important factor when deciding upon the selling price to make good profit margins and compete with rivals who offer similar products at lower prices.
There is a direct relationship between cost and profit. As more fixed costs are added, profit margins shrink. Therefore, to make more profit, prices should be raised to boost volume or reduced to boost sales. The two main methods of doing this are:
Determining the selling price of a product, which considers the cost price and market conditions to enable the product to be sold at market prices or higher. The company’s competitors can also influence the selling price while setting it to create competition amongst manufacturers, thereby driving down costs and increasing sales volumes.
The selling price of products is determined using a markup formula where the desired profit margin is multiplied by its cost and then divided by 2.
A markup formula is a process by which a company sets its selling price to be higher than its cost. The company then takes the additional profits and uses it to cover indirect fixed costs, maintain or expand operations, or even increase investment size.
Markup = Cost Price – Market Price = Cost Price – Markup = Markup
Following are the steps involved in calculating the markup formula:
There are three variables in calculating total margin: gross profit, selling price, and selling expense. Their relationship should be defined by referring to a rate table. A rate table shows the relationship for each 1% change in each variable. The total percentage margin measures the gross profit and selling price variation.
Total Percentage Margin = Total (Gross) Profit / Selling Price * 100.
Calculating margin, which is used to decide upon prices that generate desired gross profits, is done according to the following steps:
The selling price can be determined by using the following formula:
Therefore, the selling price for a company that has a fixed cost of $400,000 and a variable cost of $120 per unit is given as follows:
Revenue is also referred to as sales income or turnover when calculating revenue in accounting. It is the total income received by a company on selling its products or services.
Revenue can be calculated in two ways:
The top-line method calculates revenue by adding gross profit and subtracting expenses incurred to produce and sell products or services. While the bottom-line method considers all operating expenses, interest expenses (as well as other deductions) are deducted from sales to determine profitability. The difference between the two methods is that one adds up all revenues with gross profit, whereas another adds up all revenues after deducting expenses incurred.
The following are the formula used to calculate revenue using TOP LINE methods :
Let’s say, Company A keeps its books of account following the bookkeeping process. The Company has invested $50,000 in purchasing machinery and other fixed assets during the year. Of this investment, only $35,000 remains as inventory, and the rest ($15,000) is used for repayment of interest on loans and for expansion. The following table gives the details:
In this case, no additional working expenses were incurred during the year as the direct labor cost was $10,000 (which includes wages paid to employees). The wages paid to employees were $75,000, while salaries paid to employees were $15,000.
The cost of goods sold is the cost incurred in producing the products, including direct labor, material expenses, and other manufacturing costs. It also comprises indirect fixed costs such as rent, depreciation, insurance, etc. The cost of goods sold should be larger than the gross profit of a firm.
Revenue can also be calculated using BOTTOM LINE methods as follows:
In accounting terms, revenue refers to sales income derived at each border, like an international line like customs duty or physical boundary lines like shipping docks. Revenue is also known as selling income or turnover.
So, total revenue (revenue earned) is the total gross profit and selling expenses. This method calculates a company’s sales revenue during a period. It is also known as the “bottom line” or “top line” method of calculating profit. In this method, all expenses incurred in producing and selling goods are deducted from gross sales before calculating profit.
Let’s take an example where Company A earns $1,000 on selling product A for its cost price ($500) and operates at a constant rate for three consecutive years continuously. The following table gives details:
In this case, company A has earned a turnover of $20,000.
In accounting terms, return on investment or ROI is used as an indicator to measure the performance of a business. It is calculated as follows: ROI = Profit / Investment. ROI gives an idea of whether the project will be profitable or not. It can also compare investments and determine which projects are more profitable.
The company earns the total revenue from all its different sales or services. While calculating the total, ensure to include the value of goods and services before they are made and sold. Then, divide that number by expenses such as the cost of goods sold, selling expenses, and general expenses. The result will give you the firm’s gross margin per unit of sale. This number is then multiplied by units sold to reveal your net profit per sale (or, in other words: what’s left over after all costs).