By: Ruth King
The two terms are different but unfortunately are used interchangeably. If you report sales instead of revenue on your profit and loss statement, it might be wrong.
A sale is a sale. Revenue is that portion of the sale that is billed and accounted for. If your company is totally COD, then revenue equals sales each month. Here are three examples where sales and revenues are not equal.
Example #1 – Project that takes 4 months to complete
You sell a $1 million project which is to be completed over a period of 4 months. The sale is $1 million. The entire $1 million does not appear on your profit and loss statement the month that it is sold unless the entire project is completed in a month. If the entire project is completed in a month, sales and revenues are the same.
Please note: I am making this simple – not using work in process, completed contract or percentage of completion accounting.
If the project is installed over a period of months, generally the project is billed over several months.
The revenue, which appear on your profit and loss statement, is the amount that is billed for that month. The total revenues, over the period of time that the project is performed, equal the sale amount. If the project takes 4 months from start to finish, and a quarter of the project is completed each month, then the revenues that are accounted for on your profit and loss statements are $250,000 a month…not $1 million. The expenses incurred to produce those revenues are also in the same month.
Example #2 – Maintenance plan or other recurring revenue paid in advance (or on monthly billing)
Assume your customer pays you $250 each January for their maintenance plan. The maintenance visits are in April and October.
The sale is $250. It is recorded as $250 deferred income on your balance sheet rather than a $250 sale on your profit and loss statement.
Why? You received money for work you have not performed. This is a liability to perform work.
When you do the first maintenance in April, your liability to perform is cut in half. $125 is now recognized as revenues on your P&L and your deferred income is cut in half.
You must recognize the revenue in the month you performed the work. If you don’t you’re going to be busy doing maintenance and have nothing to show for it on your P&L. This is why I often hear the complaint, “we’re busy and losing money.” If the maintenance plan is priced and accounted for properly, you’ll be busy and at least breaking even because the revenue and expense are accounted for properly.
Example #3 – Deposits for work to be performed
Your salesperson sold a project and a deposit is required before work is performed. The deposit is not a sale. Like maintenance money received in advance, the deposit is a liability to perform. You are getting money for work you have not done yet. When you get the deposit, it is shown as a deposit in the current liabilities segment of your balance sheet. When you perform the work and bill for the work, the deposit is applied to the revenue and the total is reported on your profit and loss statement.
Make sure that you account for revenues, not sales on your profit and loss statement. This way you can see whether your company is really profitable each month.
Ruth King is known globally as the “Profitability Master,” and is a a thought leader in entrepreneurship and business. Her books have been recognized as among the greatest in numerous industries. Learn more about all her business activities here.