Revenue is the primary focus of many business owners, and with good reason. Getting money flowing into your business is the first step toward success and profitability. In fact, without revenue you don’t have a business.
Since revenue is so important, it must be easy to understand, right? Isn’t any money coming into the business revenue?
Actually, not all money coming into your business is considered revenue. And the inflow that is revenue takes several different forms. It’s important to understand how each type of revenue impacts your business accounting and financial statements.
When you think about your business’s revenue, you are probably thinking about a very specific type of revenue: operating revenue. Both operating revenue and non-operating revenue have a positive impact on your business’s finances, but they are not created equal—nor are they reported the same way on your financial statements.
So, what is operating revenue, and how does it differ from non-operating revenue? How can you tell the two types of revenue apart, and why is it important to do so? Let’s start with a brief operating revenue definition and several examples.
Operating revenue comes from your business’s primary income-generating activity or activities. You might already familiar with operating revenue, but just know it by a simpler name: sales.
When you first start your business, you will probably only have one or two income-generating activities. These activities are usually directly related to the sale of your product or delivery of your service. As your business grows, though, you will likely develop other income-generating activities in your business. Not all of these income-generating activities produce operating revenue, though.
Let’s clarify what operating revenue is—and what it is not—with a series of examples.
Let’s say a business produces income in three different ways:
Which of these three income-generating activities represent operating revenue?
It depends on the business. Here are three examples of how these three types of income-generating activities impact three different types of businesses.
A retail business typically will produce operating revenue from the sale of merchandise. However, that same business might occasionally bring in an outside expert to provide a workshop (service) for customers; this is common in craft and home improvement stores. Additionally, whenever the business is considering launching a new product, they might do some crowdfunding (where they solicit contributions from donors).
This retail business has three types of income, but only one—the sale of merchandise—is operating revenue.
A nonprofit organization, on the other hand, often produces their operating revenue through contributions from donors. But they might also sell merchandise (like T-shirts, window decals, and tote bags) to raise awareness for the organization. Sometimes, a nonprofit will even provide a service—like a community fair—at a reduced cost.
Like the retail business, the nonprofit organization has three types of income, but only the contributions from donors is considered operating revenue.
A service-based business—like a preschool—sells services to their customers, and the customers pay for those services through tuition. Like the nonprofit organization, the preschool might also sell merchandise, either to raise awareness or promote community spirit. Once a year, the preschool might do a fundraising campaign to encourage past customers and other members of the community to contribute to the preschool’s capital fund.
In this example, the preschool—like the retail business and the nonprofit organization—has three types of income. But only the tuition from the service provided to their customers is considered operating revenue.
As you can see from these three examples, what is operating revenue for one business might be non-operating revenue for another. To further complicate things, different businesses within the same business type might have different primary income-generating activities. In the example of the retail business, workshops and classes could be offered on a regular basis, and so they would be considered operating revenue.
So far, we’ve been very careful to use the word “revenue” when referring to the cash inflow from your primary income-generating activity. The words income and revenue are often used interchangeably, though. There aren’t any problems with this, as long as you are certain you understand the meaning of the words as they pertain to your financial statements. Let’s take a closer look at operating income vs. revenue.
Typically, “revenue” means operating revenue, or “top-line” revenue (“top line” because it is the first number on your income statement). In other words, revenue is the total amount of money coming into your business from your primary business activity, less any refunds or returns. The financial statements produced by many modern accounting software packages refers to revenue as “total income.”
On the other hand, operating income is your income after subtracting the operating expenses in your business from your gross profit. Your cost of sales—or cost of goods sold (COGS)—is deducted from your revenue (total income) to calculate your gross profit. Operating expenses are the expenses that go into running your business: rent, administrative costs, supplies, etc.
Operating income is like net income—or your bottom line—except operating income doesn’t include interest, taxes, or non-operating income.
The important thing to keep in mind here is that operating income is not the same as operating revenue/top-line income/total income. Operating revenue or total income is the total cash inflow from your primary income-generating activity. Operating income is the income you have after subtracting the costs of doing business. When you are discussing your financial statements with your accountant or bookkeeper, make sure you are clear about the terms he or she is using.
Operating revenue appears on your income—or profit and loss (P&L)—statement. As mentioned above, it is the top line—or total income—on the income statement. If you issued refunds in your business, they are subtracted from the total sales to arrive at operating revenue (sometimes also called “net sales”).
Understanding your operating revenue—what it includes and what it doesn’t—allows you to make year-over-year comparisons of your income statement. At a glance, you can assess the health of your business using the metric of revenue.
If operating revenue and non-operating revenue were combined on your profit and loss statement, unusual activity—like the sale of a piece of equipment—could lead you to make an incorrect assessment of your business’s revenue trend. This, in turn, could cause you to make potentially devastating decisions about your business’s direction.
As we stated earlier, not all money coming into your business is considered revenue. And revenue itself can take many forms, not just operating revenue. Here’s a look at some other types of business revenue and non-revenue.
Not all revenue that comes into your business is from your primary business activity. Therefore, not all revenue can be considered operating revenue. Revenue that is not considered operating revenue is instead classified as non-operating revenue. In the examples earlier:
There are other types of non-operating revenue that can impact your profit and loss statement:
All these examples of non-operating revenue have two things in common:
Non-operating revenue is typically found toward the end of your profit and loss statement, below operating income and above net income/profit (the “bottom line”). This allows you to clearly see your business’s financial position from operating activities, prior to the impact of non-operating revenue.
Not all cash that comes into your business is from operating revenue or non-operating revenue. Investments from shareholders, contributions of cash from owners, and loan proceeds are all examples of non-revenue cash inflows.
You can find all your operating and non-operating expenses on your profit and loss statement. Non-revenue cash inflows, on the other hand, are found on the balance sheet. And the impact all the different cash inflows—operating revenue, non-operating revenue, and non-revenue—has on your business’s cash balances is found on the statement of cash flows.
Revenue is the lifeblood of your business. Without revenue, you don’t really have a business at all. And although any money coming into your business is a good thing, in order to accurately gauge your business’s health you need to be able to quickly determine your operating revenue.
Operating revenue is what your business makes from its primary income-generating activity. Because all businesses are different, what is operating revenue for your business might be non-operating revenue for the business in the office next to yours.
You can easily find your operating revenue on your profit and loss, or income, statement. It might go by another name like “total income,” but regardless of what it’s called by your accounting software package, it is the top line of your P&L after refunds are deducted.
As your business grows, non-operating revenue will likely impact the cash inflows in your business. It’s important to separate this revenue from your operating revenue in order to maintain a clear understanding of how your business’s primary income-generating activity is performing.
Operating revenue isn’t the only important metric in your business. Gross profit, operating income, and net income all tell you slightly different things about the health of your business. Your accountant or bookkeeper can help you track trends in these metrics, as well as provide guidance on the ones which are most important for you to focus on at your stage of business.
Billie Anne Grigg is a contributing writer for Fundera.
Billie Anne has been a bookkeeper since before the turn of the century. She is a QuickBooks Online ProAdvisor, LivePlan Expert Advisor, FreshBooks Certified Beancounter, and a Mastery Level Certified Profit First Professional. She is also a guide for the Profit First Professionals organization.
Billie Anne started Pocket Protector Bookkeeping in 2012 to provide an excellent virtual bookkeeping and managerial accounting solution for small businesses that cannot yet justify employing a full-time, in-house bookkeeping staff.