Revenue is one of the top financial metrics for measuring business success. While it might seem like the more revenue, the better, that’s not always the case for your bottom line. It can be essential to understand how revenue affects profit so you can find strategies that help optimize your financial performance.
What Does Revenue Mean?
Revenue is what a business earns from selling its products and services before expenses. Revenue is also called gross sales. The more you sell, the higher your total revenue. Your profit is what’s left over after you deduct your business operating expenses from the revenue. If you make $500,000 in revenue and have $400,000 in expenses, your profit is $100,000.
Since sales go in cycles, your business revenue can increase and decrease over time. With revenue forecasting, you can try to predict future revenue based on past sales data. That way, you can plan how much money you’ll have available for spending to hopefully avoid a surprise cash crunch.
What Is Revenue in Business?
Revenue in business counts the total amount of money you bring in for selling products and services over a set period. The way a business brings in revenue depends on its business model. Some possible ways to earn revenue include:
- The direct sale of goods, products, and services
- Subscriptions, licenses, and other types of recurring, repeating revenue
- Advertising revenue
- Affiliate revenue and commissions for selling other companies' products
Your business should consider dividing revenue between operating and non-operating. Operating revenue is money you earn from running your core business activities. Non-operating revenue is any other money you might bring in.
For example, if you run a store, your operating revenue is what you earn by selling products to customers. If you rent your unused backroom to someone else for storage and earn interest on a bank account, that’s non-operating revenue. Money’s still coming in, but not from your main business activities.
You can track your business revenue and expenses on your income statement, one of the three primary financial statements. Businesses usually update their income statement with the latest revenue each month or quarter.
Understanding Revenue Management
Now that you understand what revenue means, the next step is figuring out how to bring in more of it. Revenue management is a strategic look at your pricing, customer demand, and sales and marketing strategies to find ways to improve. For example, consider pricing. Customer demand goes up as prices go down. If you cut your prices, you may make more total sales, but less per sale.
A revenue management strategy would search for the price point that earns you the highest total revenue. Let’s say you experiment with different prices throughout a quarter and find the following:
- January: $50 per unit leads to 1,000 sales and $50,000 in revenue
- February: $45 per unit leads to 1,350 sales and $60,750 in revenue
- March: $40 per unit leads to 1,450 sales and $58,000 in revenue
In this basic revenue management example, the business performs best by charging $45 per unit.
Revenue Optimization Strategies
With the concept of revenue management in mind, there are several common strategies businesses can use to optimize it:
- Dynamic pricing: Dynamic pricing is when you change prices in response to demand. Customers may be willing to pay more for a product or service at different times of the day and year. For example, rideshare companies often use surge pricing during rush hour, and hotels often charge more during the holidays while giving discounts during the off-peak travel season.
- Customer-segmented pricing: Customers have different budgets and abilities to pay for products and services. You could adjust your pricing based on a group’s financial situation. That way, you can bring in the most revenue from customers willing to pay more while still earning some sales from those with fewer resources. Student and retiree discounts are an example of customer-segmented pricing.
- Diversified revenue streams: Selling various products and services can lead to more consistent revenue as you don’t have all your eggs in one basket. If one revenue stream slows down, you still can earn from the others. You could also diversify across sales and marketing channels. For example, you can use a combination of direct sales, e-commerce, and outsourcing to allow third parties to sell your products.
- Sales/marketing efficiency: You can consider which of your products and target customers lead to the highest revenue relative to sales and marketing and then prioritize these moving forward.
- Technology for revenue optimization: Revenue optimization means constantly tracking and studying your sales and pricing data. Enterprise resource planning (ERP) and customer relationship management (CRM) software can automatically track your business activities, sales, and client profiles to generate the information needed for revenue optimization strategies.
You might consider incorporating these optimization strategies as you develop your business action plan for growth.
How Does Revenue Affect Profit?
Revenue generally has a positive impact on profit. After all, the more you sell, the more you earn, which generally translates to higher profits. However, you can also consider the expenses to generate the extra revenue. If your costs increase more quickly relative to your revenue growth, you might hurt your profits by expanding.
If your costs increase more quickly relative to your revenue growth, you might hurt your profits by expanding.
For example, you could land a $100,000 new contract from an out-of-state client, but it requires hiring another salesperson and paying for travel. The expenses add up to $80,000, leaving you $20,000 in profit. On the other hand, you could generate $40,000 in revenue by selling to local customers with only $10,000 in expenses, creating $30,000 in profit. In this case, less revenue growth leads to a better after-profit situation.
Most businesses can consider focusing on profit maximization, since that’s what you take home. There are situations when revenue maximization might make sense, even if it leads to lower short-term profits. Perhaps you want to expand into a new market with the plan to control expenses to boost profits later or you’re trying to raise money from investors who want fast revenue growth. Still, most revenue management strategies prioritize profit maximization as well.
Future Trends in Revenue Management
Revenue management is becoming more accessible and more important to small-business owners. Here are some emerging trends:
- Growth of big data: Data and analytics are the foundation of revenue management. As big data improves and becomes more affordable, more businesses can access the information they need to adopt these strategies.
- Dynamic pricing in more industries: Dynamic pricing is not just for ride-share companies, as other companies are experimenting with real-time pricing trends. For example, a fast food restaurant may consider adjusting menu prices throughout the day. More companies may adapt dynamic pricing, especially with online sales.
- Personalized pricing: Revenue management means finding the exact price a potential buyer is willing and happy to pay. As more consumer data emerges, it may be easier for businesses to finetune what they offer, creating the right combination of costs and benefits per customer while improving profit maximization.
- More access to customer data for forecasts: Newer businesses might not have the information needed for revenue optimization strategies, but services are launching to give them this historical and forward-looking data for forecasting. That way, they can learn from actual pricing trends rather than trial and error.
The Takeaway
Even a basic understanding of how your revenue and profitability interconnect can help you make better financial decisions. As part of planning your next moves, you can follow this step-by-step guide to forecasting revenue and profits using your sales data.
Photo: Getty Images
