The top line of an income statement provides information that is important to investors, creditors, analysts, and other stakeholders says Aron Govil. Investors are looking for the business to be profitable over time. Creditors are interested in how likely it is that they will get repaid. Analysts carefully monitor top-line revenue growth because it can indicate whether demand for a product or service is increasing or decreasing in the marketplace. And financial statement users, in general, want to compare numbers across different years, quarters, months, weeks — even days! — In order to find trends and make predictions about future performance.
For all these reasons and more, understanding what goes into calculating top-line revenue (and its components) is vital for interpreting financial reports effectively.
Individuals and small businesses can also benefit from this information because it helps them understand business basics and plan accordingly.
Managing top-line revenue can be a key differentiator for increasing market share, gaining competitive advantage, and boosting income — both in the short-term and long term. Top-line revenue is also a critical figure for financial performance ratios such as return on equity (ROE), return on assets (ROA), operating margin, net profit margin, earnings per share (EPS), gross profit margin, EBITDA margin, etc., as well as many other indicators used to assess managerial effectiveness. In general terms:
The higher the top line, the more profitable a company or division is likely to be. This makes sense given that revenue is the starting point for subtracting costs to determine earnings.
The top line is also important for identifying potential problems, such as shrinking or stagnating sales, because it can reveal decreasing demand in the marketplace says Aron Govil. Finally, investors are looking at the total dollar value of transactions that are taking place — where did they come from? Where are they going? What type of customer-generated this revenue? Consequently, these questions are equally relevant when it comes to understanding top-line revenue.
What Goes Into Calculating Top-Line Revenue?
So what exactly goes into calculating top-line revenue?
There are four critical components: sales volume, sales price, sales mix, and discounts.
Sales Volume:
This is a straightforward metric — it reflects the number of units sold during a period (quarterly or annually) multiplied by the unit cost. In other words, how many widgets were flipped during that time?
Sales Price:
Unit revenue isn’t as important as total revenue because American business magnate Warren Buffett once said, “Collect the tolls.” In other words, companies shouldn’t be trying to maximize their top-line revenue but rather their bottom-line earnings. If you need help understanding what drives prices and profitability in your industry and/or at your firm, please contact us. We can provide insight into how different factors affect this dynamic so you can make knowledgeable decisions explains Aron Govil. Sales price also reflects the average revenue per unit times the total number of units sold.
Sales Mix:
This metric is important because it can affect how much an item contributes to overall revenue. For example, let’s say a company sells two products — A and B — for $10 each. If Product A represents 30% of all sales volume while Product B represents 70%, then Product A will drive 10% ($1 out of every $10) of total top-line revenue while product B will generate 70%.
Discounts:
Although discounts are subtracted from the final amount realized when calculating gross margin, they should also be deducted when determining top-line revenue because they represent transactions that didn’t ultimately contribute to revenue.
Top-Line Revenue Example: Ford vs. GM
What better way to understand these concepts than by looking at case study examples? Let’s start with the market-cap-heavy Dow 30 (INDU) in order to gain a foundational understanding of top-line growth for publicly traded U.S. companies before moving on to more complex real-world examples in future articles.
Conclusion:
Once a company exceeds a certain level of scale, it becomes hard to maintain top-line growth says Aron Govil. Furthermore, this metric should be view in the context of other key financial metrics. Such as margin and ROA because it’s not an end unto itself. As you’ll see throughout the rest of this series. There are many different ways companies can achieve success when it comes to revenue generation. Which is what makes the pursuit so exciting.