When you first become a sales rep, you likely know of only one type of revenue. But as your career grows, you begin noticing different types—marginal revenue, deferred revenue, net revenue, and others. Each of them requires a unique revenue formula.
One isn’t better than another. Every formula offers a distinct perspective about your company’s revenue that can empower you to strengthen your organization.
To help you evaluate your company’s finances, we’ll break down five key types of revenue—what they mean, how they’re calculated, and how to evaluate them.
Total revenue: The easiest way to calculate sales revenue
Total revenue, also known as gross revenue, is one of the simplest, most common ways for business owners to calculate sales revenue. It determines the total income generated from goods or services sold.
Total revenue doesn’t deduct any of the expenses that go into selling a product or service, so it won’t give you a detailed picture of the health of your business or your sales. But if all you want to know is how much cash you brought in, total revenue is the number you need.
Total revenue formula
To calculate total revenue, multiply the number of units sold by the consumer price of each item.
For example, if you sell 500 Xboxes priced at $249 each during the month of May, the total revenue for that month is $124,500.
Why total revenue is important
Total revenue reflects your ability to sell a product or service. If your total revenue is higher than that of your competitors, it’s a sign of greater market interest in your offerings.
For a newly established company, total revenue is sometimes considered a measure of success. Startups are often operating at a loss for the first few years, so investors look at their total revenue to evaluate demand for their products or services.
But total revenue isn’t always a reliable indicator of success. It doesn’t take expenses or costs into account, so it tells you nothing about a company’s profitability.
Total revenue is the most basic way of calculating sales revenue, and you should treat it that way—as a rough guide to the health of your business and nothing more.
Net revenue: Accounting for cost to determine profit
Net revenue, or net income, refers to total revenue minus the cost of goods sold (COGS). If you’re selling a physical product, COGS might include raw materials and manufacturing overhead. For software companies, COGS would likely be hosting fees or salaries for software developers.
Compared to total revenue, net revenue gives you a clearer idea of how your business is doing because it takes expenses into account. Say your total revenue from sales is massive. If you acquired that revenue by spending more money to promote your product and didn’t sell enough to earn back that money you spent, then your net revenue would reflect that loss.
Net revenue is typically the bottom line on your income statement.
Net revenue formula
Calculating net revenue simply entails subtracting COGS from total revenue.
Consider the Xbox example referenced above. In May, you sell 500 Xboxes priced at $249 each, resulting in a total revenue of $124,500. It costs $200 to make a single Xbox, so the COGS for 500 units is $100,000. Subtract COGS from total revenue, and you get $24,500 in net revenue.
The net revenue formula should give you a better understanding of your balance sheet—how your expenses and income cancel each other out. Use it to identify any opportunities for reducing your COGS and improving profitability.
Why net revenue is important
Ignoring net revenue means ignoring the question of whether you’re profitable. If you start treating total revenue like money in your pocket, you could end up spending more resources than you can make up in sales. As a result, you won’t be able to pay employees, and you won’t be able to pay for the overhead expenses needed to keep a business running.
Net revenue still doesn’t tell the entire story of how a company is doing, but it provides a more complete picture than total revenue does. Track net revenue so you know the profits you’re making. Then, you can properly budget for future expenses and use your financial statements to show potential stakeholders your company does promise a return.
Deferred revenue: Tracking prepayments separately
When companies receive payments for products or services they haven’t yet delivered, that’s called deferred revenue. Payments are considered “recognized” once the company has fulfilled its end of the agreement.
Say you’re a B2B company that sells subscription-based software. You generally charge $10 a month, but many customers opt to pay annually instead. Customer A pays you $120 in full on January 1. At the end of January, you’ve successfully delivered one month of services, which means you can “recognize” $10 in revenue. The remaining $110 is considered deferred revenue.
Deferred revenue formula
To calculate deferred revenue, add up all advance payments for services and products that will be delivered at a future time.
For example, if 10 customers pay $1,000 in advance for undelivered services, your deferred revenue is $10,000.
Why deferred revenue is important
For subscription-based sales models, deferred revenue can make or break your business—that’s because it’s considered a liability, not income.
If you fail to deliver a service or product that you promised to a customer—which can happen, for one reason or another—and they’ve already paid you, then you’ll need to pay them back. Spend that money, and you may end up in a tight spot where you can’t repay the customer.
Keep an eye on deferred revenue to ensure you’re not spending money that isn’t technically “in your pocket.” Treat deferred revenue as something you may still need to give back—not as money that’s yours to do with what you like.
You can also use deferred revenue to calculate the cost-effectiveness and the efficiency of your customer-acquisition strategies. To use the example above, if it takes $100 in marketing and sales to acquire a customer, it will take 10 months of $10 monthly subscription payments to gain those costs back. If you can reduce the time it takes to recover acquisition costs, your company will be able to grow its cash flow more quickly.
Marginal revenue: Monitoring changes in revenue
Marginal revenue is the average increase in revenue that comes from selling one additional unit. That unit can be one book, one computer, one service to a customer—whatever the basic unit of production is for a company.
Marginal revenue formula
To calculate marginal revenue, divide the change in total revenue by the change in production quantity.
Say a company sells 12 books at $20 dollars each, for a total revenue of $240. They then sell 11 books at $22 dollars each, for a total revenue of $242. The difference in total revenue is $2, and the difference in quantity is one book, which means the marginal revenue for the 11th book is $2.
Why marginal revenue is important
Track marginal revenue so you know whether you’re still making money as you ramp up production or whether you’re throwing money down the drain.
Say you’re trying to decide how many units to produce (and what average price to assign them) to turn a profit. Each new unit costs a certain amount to produce—that’s the marginal cost. Each unit sold also contributes to your income—that’s the marginal revenue. In combination with marginal cost, marginal revenue can tell you the ideal number of units to produce before you stop making more money.
Generally, as you keep producing and selling more units, your marginal revenue will go down. You’ll know to stop increasing production when the marginal revenue equals the marginal cost.
Annual recurring revenue: Adding up revenue from subscriptions
Annual recurring revenue (ARR) is the amount of money a business makes over the course of one year from subscriptions or contracts—anything that makes money over a defined period of time.
Annual recurring revenue formula
Calculating annual recurring revenue requires taking an amount of recurring revenue and normalizing it to cover one year. For example, if you charged 12 monthly subscriptions, multiply the monthly cost by 12. If you charged one two-year subscription, divide that two-year cost by 2.
If a customer signs a one-year contract for $4,000, that’s $4,000 in annual recurring revenue—simple enough. If they sign a three-year contract for $9,000, divide the amount by the number of years; this gives you $3,000 in annual recurring revenue for that customer for each of those three years.
It works in the opposite direction over shorter periods of time. If a customer paid $300 each month for a year, then you would multiply by 12 months to get the annual recurring revenue, which would be $3,600.
Why annual recurring revenue is important
Annual recurring revenue isn’t a snapshot of how much you’re making at a particular moment in time—it’s a reliable picture of how much you can expect to take in over the course of a year.
If a charge doesn’t repeat, then it’s not something you can count on for the future and doesn’t belong in your annual recurring revenue. But if your company relies largely or totally on revenue from recurring sources, annual recurring revenue is an essential tool in figuring out the health of your business and forecasting revenue.
Plan for sales growth by taking a holistic approach to revenue
To get a solid handle on your company’s finances, take a holistic approach to revenue, with the total revenue formula as a starting point. Then, use the other formulas to analyze the bigger picture for a more complete understanding. These insights can ultimately lead you to understand how to increase profit margins and grow your business.
To help you keep tabs on your key sales metrics, invest in a tool like Zendesk Sell, a CRM system that helps you manage sales data, monitor your pipeline, and perform sales forecasting. This software solution integrates with tools you’re likely already using—from Mailchimp to Shopify—and quickly turns customer interactions into valuable, data-driven sales reports.