A Closer Look At Revenue

Different businesses call it different things. Sales, gross receipts, proceeds, they all boil down to a company’s top-line: Revenue.

First, let me explain what top-line means. Companies usually keep track of their profits and expenses on a financial statement called an income statement, or “P&L”, which stands for profit and loss. It summarizes the amount of money coming into the firm minus the money going out of the firm.

There are several different items that comprise the P&L, but I am only concerned with the TOP line item: Revenue.

Revenue is another name for sales. But an important thing to understand is that revenue, at its core, is an equation, represented by the following model:

Revenue = Price (Per quantity) * Quantity

Let’s take an example: Suppose I run a pencil store. We’ll call it Bryan’s Pencils.

I have great connections in the pencil-wholesale world, so I get a deal: I can purchase 100 pencils for $100. That’s the same as buying each (one) pencil for $1.

The pencil wholesaler lives across the street from me, so travel and shipment costs are negligible. I open my doors for business and decide to sell each pencil for $2.

Thank goodness I live right next to a high school, so all my pencils are sold by day’s end. I close up shop having sold 100 pencils and earning $200 in revenue:

$2(per pencil) *100 = $200 Revenue

 This is not the only way I could have earned $200 in revenue. I could have executed any of the following combinations:

50 pencils for $4 each

20 pencils for $10 each

10 pencils for $20 each

Etc.

Theoretically, they all yield the same result, and I will be indifferent as long as I get $200 in sales by the end of the day. However, there is an important point worth mentioning:

For a given revenue figure, an increase in price will mean a decrease in volume, and vice versa.

When analyzing historical revenue, it is invaluable to analyze the increasing/decreasing trends of price/volume.

Here is an example from the movie industry:

Let’s focus on 2012-2017E. Attendance to moving screenings has decreased at a compounded annual rate of 1.6%, while average ticket prices have increased at a compounded annual rate of 2.4%.

More simply:

Fewer people are going to movies, and ticket prices are rising.

If we compare the revenue figures taking into account this price/quantity relationship, we can see that overall revenue from 2012-2017 has grown 0.7% each year.

Revenue is only rising because prices are rising faster than actual ticket sales are.

It is imperative you understand the core components driving revenue growth/decline. If a company is reliant on increasing prices and has stagnant volume, it may not have good growth prospects, and face serious price competition from a competitor who can charge a lower price for the same profit.

My recommendation: if a company is increasing the price of its good/service, it should be proportional to the rate of inflation (the overall rate of price increases in the economy). Any higher, and the company may seem like its unit sales are declining. Any lower, however, can lead to real profit losses in an overall price-increasing environment.

All companies need revenue to pay off expenses and invest in new projects. Rising volume is a great sign of organic growth. That is sustainable and has true intrinsic worth.