Dive into the world of operating revenue: its definition, importance, and how to analyse it for business growth. Discover the risks of fraudulent reporting and how to protect your company's financial integrity.
Operating revenue is a crucial financial metric. It represents the income generated by a company’s core business operations. In simpler terms, it is the revenue derived from the day-to-day activities of a business.
This article aims to shed light on the concept of revenue, differentiate it from non-operating revenue, analyze its importance, and address the issue of fraudulent reporting.
What is Operating Revenue?
Operating revenue is also known as sales revenue or operating income. It refers to the money a company earns from its primary business activities. It encompasses revenue generated by selling goods or services related to the core business functions.
For example, in a retail business, it includes sales from merchandise sold to customers. In the case of a software company, this revenue consists of the income from
- Software licensing
- Subscriptions
- Professional services provided.
Operating Revenue vs. Non-Operating Revenue
The key distinction between operating revenue and non-operating revenue lies in their sources and relevance to a company’s core operations. It arises from primary business activities. It results from secondary or peripheral activities.
It reflects the sustained profitability of a business. It is critical for its long-term growth and sustainability. It consists of gains or losses from activities not directly tied to the core operations, such as
- Investment income
- Foreign exchange gains
- One-time asset sales.
Analysis of Operating Revenue
Analyzing It provides valuable insights into a company’s financial performance and efficiency. Here are some key points to consider:
Revenue Trends
Examining the trend in it over time helps evaluate a business’s growth trajectory and stability. Consistent or increasing revenue indicates a healthy and successful operation.
Profit Margin
By comparing it with operating expenses, a company’s profitability can be assessed. Profit margin, calculated by dividing operating income by it, shows the percentage of revenue that translates into profit.
Industry Benchmarking
Comparing a company’s revenue with industry peers allows for a comprehensive evaluation of its performance. This analysis aids in identifying strengths, weaknesses, and areas for improvement.
Cost Management
Analysing revenue enables a company to identify cost-saving opportunities. Businesses can enhance their revenue generation by scrutinising expenses and optimising operational efficiency.
Operating Revenue Examples
Generating revenue is the lifeblood of any business, and understanding the different avenues through which a business can make money is crucial for sustainable growth and success. It is the main source of funds for a business’s day-to-day operations, stems from a variety of income-generating activities.
Here are some common examples:
Sales of Merchandise:
One of the most traditional and direct ways for a business to generate revenue is through the sale of goods or merchandise. This revenue stream typically applies to retail businesses, manufacturers, wholesalers, and e-commerce ventures. Whether selling physical products in a store or online, the revenue generated from these sales forms a significant part of the operating income.
Contributions from Donors:
Non-profit organisations, charities, and similar entities often rely on contributions from donors as a key source of operating revenue. These contributions can be in the form of monetary donations, grants, sponsorships, or even in-kind contributions. The funds received from donors are vital for funding the organisation’s day-to-day activities and achieving its mission.
Providing Services to Customers:
Service-oriented businesses primarily generate revenue by providing services to clients or customers. This could range from consulting firms, healthcare providers, legal services, educational institutions, to software-as-a-service (SaaS) companies. The fees charged for the services rendered constitute the revenue, sustaining the business’s ongoing operations.
The specific mix and dominance of these revenue channels largely depend on the nature of the business and its primary income-generating activity. Some businesses may heavily rely on sales of merchandise, while others may be more service-oriented or dependent on contributions from donors.
How to Calculate Operating Revenue
Calculating operating revenue is a fundamental process for businesses to assess their financial performance accurately. It represents the revenue generated from a company’s core operations, excluding any non-operational or incidental sources.
Here’s a step-by-step guide on how to calculate operating revenue:
Calculate Gross Sales:
Begin by calculating your gross sales, which is the total revenue generated from sales before any deductions. Sum up all your top-line revenue, including both cash and credit card receipts. However, be cautious to exclude certain items from this calculation. If you provided free services or products as part of a promotional campaign, deduct the value of these from the gross sales.
Subtract Returns and Allowances:
Returns and allowances can significantly impact your revenues, so it’s crucial to account for them accurately. Deduct the total amount of returns and allowances from your gross sales. To calculate the impact of returns and allowances on your revenues, divide the total returns and allowances by your total sales. This calculation gives you the revenue generated from allowed sales after factoring in returns and allowances.
Subtract Variable Costs of Goods Sold (VCOGS):
Variable costs of goods sold (VCOGS) are expenses that fluctuate directly with business activity levels. These costs include raw materials, labour, and other costs directly associated with producing goods or services. Subtract VCOGS from the revenue generated from allowed sales to determine the operating revenue.
Operating Revenue Examples by Industry
Operating revenue, though fundamental across all industries, varies in its calculation and representation. Here’s how it manifests in different industry sectors:
SaaS (Software as a Service)
Example: XYZ Software
SaaS companies derive operating revenue from subscriptions. The calculation involves multiplying the average subscription price per customer by the total subscriber count. It specifically reflects revenue generated from the core operations, unaffected by new subscribers gained or lost within a quarter.
Retail and Consumer Goods
Example: ABC Retail
For retailers and small businesses, It is calculated as gross sales minus returns. In consumer package goods (CPG) companies, operating revenue includes new product sales and add-on sales, like accessories. Service revenues, determined through service fees earned, also contribute to the revenue in this sector.
Non-profits
Example: Good Cause Foundation
Operating revenue for non-profits mainly comprises contributions and grants received. Non-profits engaging in product or service sales incorporate the revenue generated from these transactions into their revenue calculation.
Service Industry
Example: Expert Consultancy Services
The service industry, encompassing diverse services, faces challenges in precisely calculating operating revenue. Given the varied nature and value of services provided, determining an accurate revenue figure demands meticulous assessment. One method involves calculating total revenue for the year using income statements or balance sheets, providing insights into revenue generated from each project or job.
Challenges and Considerations
| Challenges and Considerations | Description |
| Revenue Recognition Principles | Understand and comply with ASC 606 or IFRS 15 |
| Compliance Challenges | Ensure accurate and consistent revenue reporting to meet regulatory and accounting standards |
| Seasonality and Cyclical Factors | Manage revenue fluctuations due to seasonal or cyclical trends, and forecast based on historical data |
| External Factors and Market Conditions | Identify and address the impact of economic conditions, competition, and market factors on revenue. |
| Revenue Forecasting and Accuracy | Develop reliable revenue forecasts and ensure accurate estimation of future revenue |
| Changing Business Models and Revenue Streams | Adapt revenue recognition policies for shifts to subscription-based models or other business changes |
| Data Integrity and System Integration | Ensure data integrity and integrate various sources for a comprehensive view of revenue. |
| Revenue Leakage and Fraud Prevention | Implement robust processes and controls to support revenue recognition and prevent errors. |
| Ethical Considerations and Revenue Recognition Ethics | Address ethical concerns, avoiding aggressive or inappropriate revenue recognition practices |
| Continuous Monitoring and Auditing | Regularly monitor and audit revenue recognition processes to identify and rectify issues or irregularities |
Fraudulent Reporting of Operating Revenue
Here are some fraudulent reporting techniques to be aware of:
Fictitious Revenue
Sometimes, businesses make up sales that didn’t really happen or say they’ve earned money before they actually have. This makes it look like they’re making more money than they really are. This dishonest action makes the company’s financial reports look better, but it gives a false picture of how the business is doing.
Channel Stuffing
This strategy means sending more products to sellers or customers than they need. This can make it look like the company is selling more and thus making more money. The reason they do this is often to meet their short-term sales goals. This can hide problems in the business or make people think there’s more demand for the product than there really is.
Round-Tripping
Round-tripping is a shady practice. It involves making up transactions that create revenue through a cycle of fake sales and purchases among colluding companies. It wrongly boosts operating revenue without any real business happening.
Misclassification
Sometimes, companies can wrongly label non revenue as operating revenue. This gives a falsely positive financial outlook. Such misinformation can lead to wrong evaluations of a company’s performance, affecting decision-making.
Preventing Fraudulent Reporting
Robust internal controls and transparent financial reporting practices are essential to mitigate the risk of fraudulent reporting. These measures include:
Segregation of Duties
Clearly defining roles and responsibilities within the organisation and segregating duties among different employees can help prevent collusion and reduce the likelihood of fraudulent reporting.
Regular Internal Audits
Regular internal audits are helpful. They can pinpoint any strange or conflicting aspects in it reports. This helps to ensure that financial reports are truthful and reliable.
Strong Governance and Oversight
Good corporate governance and independent supervision help to prevent fraud. Boards of directors and audit committees play a key role. They monitor financial reporting and protect against dishonest practices.
Whistleblower Mechanisms
Encouraging staff to report any strange activities related to this revenue is crucial. Confidential reporting systems work best. Whistleblower protection policies safeguard those who share important information.
External Audit
Getting an external auditor to check the financial reports adds an extra layer of assurance. They can help spot attempts at fraud in reporting.
Conclusion
It tells us how a company’s main business is performing. It’s crucial to separate money from the main business (operating revenue) and money from other places (non-operating revenue). It helps to know a company’s financial strength. We can use it, as profit ratios, and industry comparisons to make key decisions.
However, some companies might falsely report to seem more financially stable. To stop this, businesses should use strong checks, and frequently look at their financial reports.
It encourages truthful behavior. This ensures the accuracy and dependability of the operating revenue data.
Vakilsearch can assist businesses in navigating the complexities of operating revenue. With their team of experienced professionals, they provide expert guidance on understanding and analyzing it, ensuring compliance with relevant laws and regulations. Contact us today.
FAQs
What is an example of operating revenue?
Sales of products or services by a company, like software subscriptions for a SaaS business or retail sales, represent examples of operating revenue.
Is operating revenue a profit?
It is not the same as profit. It's the total revenue generated from core operations, excluding costs. Profit is what remains after deducting all expenses.
Is operating revenue the same as total income?
It pertains to revenue from core business operations, while total income includes all revenue sources, potentially encompassing non-operating revenues like investments and interests.
What is operating revenue vs sales?
Sales refer to the total amount received from selling goods or services. Operating revenue is derived from core business operations, factoring in returns and allowances.
Is operating revenue a current asset?
It is not a current asset; instead, it contributes to the calculation of net income and is reported on the income statement.
What is the difference between operating revenue and EBIT?
It is the total revenue from core operations, whereas EBIT (Earnings Before Interest and Taxes) accounts for revenue and subtracts operating expenses but excludes non-operating income and expenses.
Can operating revenue be negative?
It is rarely negative, but it can occur in cases of excessive returns or allowances exceeding the initial revenue, reflecting a loss from core operations. However, it's uncommon and not a regular business practice.
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