The top 5 revenue formulas to calculate sales revenue
There’s no single perfect revenue formula, but we’ll show you how to calculate revenue based on your business’ needs.
Published February 5, 2020
Last updated April 15, 2021
As you move up in your sales career, you’re starting to hear some terms thrown around: gross revenue, net revenue, deferred revenue, marginal revenue, annual recurring revenue. What’s the difference? Why use one and not the others? Each one tells an entirely different story about your business—so we’ve put together this guide to help you stay on top of these essential terms.
There are different types of revenue, each requiring a unique revenue formula.
With these different formulas, you can approach revenue from multiple angles to get a full picture of your business’s finances. You aren’t just looking at total sales—you’re also looking at sales in relation to business factors that impact your profits.
Here are five key revenue formulas to look at:
- Annual recurring revenue adds up all the money you make from anything with periodic payments
- Gross revenue is the simplest option because it doesn’t take any expenses into account. It’s a top-line, nuance-free number that will give you a broad idea of how much you’re selling.
- Net revenue indicates how much you’re making when you include expenses, like the costs of production.
- Deferred revenue will let you know how much you’ve been paid but you haven’t actually earned yet—which may be a reason to be cautious with that money, as it’s not yet actually yours.
- Marginal revenue tells you how much more money you’re making for each additional unit you sell.
To help you evaluate your company’s finances, we’ll break down what these five types of revenue mean, how they are calculated, and how the figures are evaluated.
Let’s get started.
Gross revenue: The simplest way to calculate sales revenue
Gross revenue, also known as total revenue, is one of the simplest, most common ways for business owners to calculate sales revenue. It’s used to determine the total income generated from goods or services sold.
Gross revenue doesn’t take into account any of the expenses that go into selling a product, and it won’t give you a more detailed picture of the health of your business or your sales. If all you want to know is how much cash you brought in by selling a certain number of units, without any nuance or subtraction, gross revenue is the number you need.
Why gross revenue is important to consider
Gross revenue reflects your ability to sell a product. If your gross revenue is higher than that of your competitors, it’s a sign that there is greater market interest in your product.
For a newly established company, gross revenue is sometimes considered a measure of success. Startups are often operating at a loss for the first few years, so investors look to their gross revenue to evaluate demand for their products.
But gross revenue is also a somewhat poor indicator of success. It doesn’t take costs into account, so it tells you nothing about a company’s profitability.
This metric is the most basic way of calculating revenue, and you should treat it that way—as a rough guide to the health of your business, and nothing more.
Formula: How to calculate gross revenue
To calculate gross sales revenue, just multiply the number of units sold by the cost of your product or service.
For example, if you sell 500 Xboxes priced at $249 each during the month of May, the gross revenue for that month is $124,500. Remember, the gross revenue formula does not reflect profit. It is, however, a necessary component in calculating it.
Net revenue: Accounting for cost to figure out profit
In order tocalculate how much profit you’re making in sales, you have to deduct expenses from revenue. Net revenue—or net income—gives you a much clearer idea of how your business is doing than gross revenue because it takes expenses into account.
Say your gross revenue from sales is massive. If you acquired that revenue by pouring money in that you don’t have, your net revenue will show that debt. Net revenue is the bottom line on your income statement.
To calculate net revenue, subtract the cost of goods sold (COGS) from the gross revenue of a product. If you’re selling a product, COGS might include operating expenses, raw materials, product assembly, manufacturing overhead, and so forth. For software companies, COGS would likely be hosting fees or salaries for software developers.
Why net revenue is important to consider
Ignoring net revenue means ignoring the question of whether you’re profitable. If you start treating gross 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’s a far more complete picture than just looking at gross revenue. With gross revenue, you don’t know how much money you actually have; with net revenue, you have a clearer idea.
Track net revenue so you know the true profit made from a sale. Then, you can properly budget for future expenses and use your financial statements to show potential stakeholders that your company does promise a return.
Formula: How to calculate net revenue
Calculating net revenue is simply subtracting COGS from gross revenue.
Consider the Xbox example referenced above. You sell 500 Xboxes in May priced at $249 each, totaling $124,500 in gross revenue. Additionally, it costs $200 to make a single Xbox, so the COGS for 500 units is $100,000. Subtract COGS from gross 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.
Deferred revenue: Tracking prepayments separately
When companies receive payments for services they have not yet delivered, that’s called deferred revenue. Payments are considered “recognized” once the company has fulfilled their 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 by the year 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 until the end of February, at which point your deferred revenue is $100—because you’ve delivered another $10 worth of services.
Why deferred revenue is important to consider
For subscription-based sales models, deferred revenue could make or break your business. That’s because it’s considered a liability, not income.
If you fail to deliver a service that you promised to a customer—which can happen, for one reason or another—and they’ve already paid you, you may need to pay them back. Spend that money, and you won’t have the funds to repay the customer if you fail to deliver. You’ll be in a tight spot. Keep an eye on deferred revenue to make sure 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. 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 reducethe time it takes to recover acquisition costs, your company will be able to grow its cash flow more quickly.
Formula: How to calculate deferred revenue
To calculate deferred revenue, add all payments for services and products that haven’t been delivered.
For example, if 10 customers pay $1,000 in advance for undelivered services, your deferred revenue is $10,000.
Marginal revenue: Tracking changes in revenue
Marginal revenue is the average increase in revenue that comes from selling one more 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 is calculated by dividing the difference in total revenue for two given periods by the difference in products sold for the same two periods.
Why marginal revenue is important to consider
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. In combination withmarginal cost, marginal revenue can tell you the ideal number of units to produce before you stop making more money. The metric can also help you figure out pricing.
Say you’re a company, and 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 new unit sold also contributes to your income—that’s the marginal revenue.
Generally, as you keep producing and selling more units, your marginal revenue will go down. You’ll know to stop making more when the marginal revenue equals the marginal cost.
Formula: How to calculate marginal revenue
Calculating marginal revenue is simply dividing the change in 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, so the marginal revenue for the eleventh book is $2.
Annual recurring revenue: Adding up revenue from subscriptions
Annual recurring revenue 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.
If a customer signs a 1-year contract for $4000, that’s $4000 dollars in annual recurring revenue—simple enough. If they sign a 3-year contract for $9000, you just need to divide by the number of years, giving you $3000 dollars in annual recurring revenue for each of those three years. It works in the opposite direction over shorter periods. If a customer paid $300 each month for a year, you would multiply by 12 months to get the annual recurring revenue of $3600.
Why annual recurring revenue is important to consider
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. So 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 for the future.
Because annual recurring revenue is designed to be reliable for a whole year, it’s important not to include any one-time charges in your calculations. 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.
Formula: How to calculate annual recurring revenue
Calculating annual recurring revenue is taking an amount of recurring revenue and normalizing it to cover one year. If you charged 12 monthly subscriptions, you multiply the monthly cost by 12. If you charged one 2-year subscription, it’s dividing that 2-year cost by 2.
If the cost of a magazine subscription is $5 per month, and a publisher sells a 1-year subscription, the annual recurring revenue for that year is $60.
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. Use multiple formulas to analyze the bigger picture of how your company conducts business. With that informed perspective, you’ll be able to gain insight into how you can increase your profit margins and ultimately grow your company.
Learn more about how to enhance your team's productivity by starting a free trial of Zendesk today.
2020 State of SMB Sales
We take a look at what has changed for SMB sales teams in recent years, the main issues facing SMB sales teams, and the role of technology at small and mid-sized companies.