Operating Revenue

What is Operating Revenue?

Operating revenue is the income a company generates from its primary business activities, excluding income from non-operating sources like investments and asset sales. You’ll report it on the income statement as the top line, before deductions for operating costs, taxes, and interest. Operating revenue is also called net sales or net revenue.

Although every business has operating revenue, how exactly they calculate it varies. Retail businesses will factor in discounts and returns, while SaaS companies need to account for churn and upgrades.

Regardless, the goal is always the same: determine how much money is generated from core operations.

Synonyms

• Sales revenue
• Net sales
• Top-line revenue

Importance of Operating Revenue in Accounting

Separating operating revenue from the overall income is crucial as it sheds light on a company’s ability to render its products and services efficiently.

There are several reasons businesses need to pay attention to their operating revenue:

• Measure sales and revenue performance
• Assess profitability (by comparing revenue to operating profit)
• Analyze trends and forecast future revenue
• Value the business for investors and creditors
• Create an effective budget and financial plan
• Benchmark against against peers, industry standards, and previous performance
• Calculate taxable income
• Recognize revenue in compliance with ASC 606 or IFRS 15

While a financial statement should list operating revenue separately, there are instances where businesses blend it with other types of income. They’d do this to mask a decline in their main revenue streams (e.g., to artificially inflate their business valuation). Recognizing where the revenue comes from is key to evaluating a company’s operational well-being.

How is Operating Revenue Generated?

Depending on the nature of a business, its core activities will vary. In general, operating revenue is fairly obvious — what do you do every day to consistently earn money?

Examples of operating revenue drivers include:

• Sales of goods and services — This is the primary source of operating revenue for most companies. It includes income from sold products and services, plus add-ons, upgrades, and ancillary offerings.
• Recurring revenue — For subscription-based models and many businesses in the service sector, operating revenue includes recurring income from ongoing customer contracts.
• Fees and commissions — Companies that provide services may earn fees or commissions that are considered operating revenue.
• Rent income — When a company owns property and earns consistent rental income from its business operations, they would include this.
• Channel sales — If partnerships where external parties, such as distributors, resellers, affiliates, white-labelers, or agents, are a significant part of your monetization model, the income you generate from them is considered operating revenue.

The important thing to remember here is that you’d only consider a revenue stream to be “operating revenue” if it’s consistent. For example, a SaaS company wouldn’t include a one-time implementation fee for a large enterprise customer unless most of its customers required it and it was somewhat standardized.

Calculating Operating Revenue

There are three basic steps in the operating revenue formula.

1. Calculate your gross sales
2. Subtract returns, refunds, and allowances
3. Factor in expansion revenue

1. Calculate your gross sales

Gross sales equal the total top-line revenue you generate from goods and services within a specific period, typically a quarter or fiscal year. Depending on your business operations, this may include:

• Physical products
• Digital products
• Services (consulting, installation, training)
• Financing
• Cash and credit card receipts

Calculating gross sales is relatively straightforward for companies selling tangible goods. It’s probably right there in your billing or accounting platform.

2. Subtract returns, refunds, and allowances

Gross sales will only show the revenue you’ve generated. To find out how much money you actually made, you have to know how much of that money went back into the customer’s pocket (after all, you can’t use it to “operate”).

Here’s what to do:

• Look at all the sales you made that could be returned. If any of these items come back, subtract them from your total sales.
• Look at all the refunds and discounts that you’ve given out. Make sure these amounts are taken off as well.
• Factor in allowances (e.g., a 5% discount to account for a defective product) if they’re not already included in your sales figures.

3. Factor in expansion revenue

You might have already done this. But some companies (namely, SaaS businesses) look at expansion revenue separately to understand their net revenue retention rate.

From an accounting perspective, expansion revenue is part of operating revenue. It includes:

• Upgrades
• Upsells
• Cross-sells
• Add-ons
• Renewals

Operating Revenue vs. Non-Operating Revenue

The important distinction with all these drivers is that they must be part of your everyday business operations and overall revenue strategy. If, for example, you sell off a portion of your assets, that income would be considered non-operating revenue because it doesn’t contribute to consistent cash flow.

Non-operating revenues include one-off gains or losses from events like:

• Lawsuits
• Insurance reimbursements
• Foreign exchange fluctuations
• Write-downs

The reason for the distinction is that operating revenue reflects how much money a company can make through its core business activities. The abovementioned types of revenue may still be significant, but they don’t speak to day-to-day business performance.

Operating Revenue vs. Operating Income

Operating revenue and operating income sound similar, which is why they’re sometimes confused. But they’re two distinct financial metrics that underscore different aspects of a company’s financial performance.

• Operating revenue reflects the total amount of money a company makes from its primary business activities, such as selling goods or services. It’s the starting point of an income statement and indicates the effectiveness of a company’s core operations in generating sales.
• Operating income — also called operating profit — is calculated by subtracting all operating expenses (like cost of goods sold, salaries, rent, utilities, and depreciation) from your operating revenue. It measures the profit a company makes from its operations after covering all the costs of running the day-to-day business.

Comparing operating revenue directly with operating income isn’t always insightful because of this distinction. Since operating income considers costs, how efficiently a company manages its operating costs influences it directly, independent of revenue performance.

If you need to compare them, it’s best to do so based on earnings per share (EPS). This tells you how much profit each share of the company generates, which investors a sense of a company’s profitability on a per-unit-of-ownership basis.

Examples of Operating Revenue

Retail

Operating revenue is easiest to calculate for retail businesses. It’s simply the total bill for all goods sold (gross sales), minus returns.

For CPG and FMCG businesses, you’d look at new product sales plus add-ons, minus allowances.

Servitized retail businesses would also consider service revenues here.

SaaS

SaaS operating revenue is also quite simple. It’s the revenue it generates from subscriptions.

Most software companies determine this revenue figure by multiplying the average revenue per user (ARPU) by the number of customers and subtracting churn.

Nonprofits

Nonprofits are a little more difficult to calculate because they don’t “sell” per se (or, at least, they sometimes don’t). But nonprofits do have operating revenue, such as from donations, grants, and program service fees.

To calculate operational revenue for a nonprofit, you’d subtract the cost of fundraising activities from their gross income (what they receive in donations, grants, and, potentially, sales revenue) to arrive at net contributions.

Manufacturing

In B2B manufacturing, operating revenue calculations get more complicated, especially if you’re a contract manufacturer selling highly configurable engineer-to-order products (like medical devices or industrial equipment). When all your revenue comes from contracts that vary wildly in value, scope, and length, you can’t always look at operating revenue over shorter periods.

It’s best to calculate operating revenue by looking at your earnings over the course of a year. That way, you’ll have an idea of the impact of each contract on your net sales numbers.

Impact of Operating Revenue on Financial Health

Your ability to generate revenue from core business functions reflects sales efficiency, scalability, product-market fit, and overall business growth potential. Consistent operating revenue growth generally indicates a healthy demand for a company’s products or services, which is a positive sign for long-term viability.

That’s why investors, lenders, and shareholders look at operating revenue when evaluating the viability of a company.

• High or growing operating revenue means investors will value your company more favorably.
• Strong operating revenue streams enhance your company’s credit profile, which makes it easier to obtain financing (at favorable terms).

But to get a clearer view, you’ll also need to look at non-financial metrics, like customer satisfaction and employee engagement. These provide insight into how well your business is performing in terms of generating repeat business (customer loyalty) and maintaining a strong team (employee retention).

Non-operating income isn’t necessarily bad, but including it in the primary business performance metric is a bit misleading. You need to understand the difference between operating and non-operating revenue to accurately assess your company’s financial health and potential for growth.

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