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Revenue/Sales/Top Line
Definition
Revenue (also known as sales) refers to the value of what a company sold to its customers during a given period. On the income statement it is the top line. (Watch out, though. Some companies call that top line “income,” which is wrong. Income is the same as profit, also known as the bottom line.)
A company typically records a sale (i.e., includes it in their income statement) when it delivers a product or service to a customer. Although that sounds simple, putting it into practice can be quite complex. The issue of “when is a sale a sale” is one of the more artful aspects of finance. If you look in any public company’s 10-K (reported financial information), you’ll likely find pages dedicated to how the company recognizes revenue.
Example
Book Excerpt
The pressure for manipulation can be intense. Let’s take a software company, for example. And let’s say that it sells software along with maintenance-and-upgrade contracts extending over a period of five years. So it has to make a judgment about when to recognize revenue from a sale.
Now suppose this software company is actually a division of a large corporation, one that makes earnings predictions to Wall Street. The folks in the corporate office want to keep Wall Street happy. This quarter, alas, it looks as if the parent company is going to miss its earnings per share estimate by one penny. If it does, Wall Street will not be happy. And when Wall Street isn’t happy, the company’s stock gets hammered.
Aha! (You hear the folks in the corporate office thinking.) Here is this software division. Suppose we change how its revenue is recognized? Suppose we recognize 75 percent up front instead of 50 percent? The logic might be that a sale in this business takes a lot of initial work, so they should recognize the cost and effort of making the sale as well as the cost of providing the product and delivering the service. Make the change – recognize the extra revenue – and suddenly earnings per share are nudged up to where Wall Street expects them to be.
Interestingly, such as change is not illegal. An explanation might appear in the footnote to the financial statements, but then again it might not. In principle, any accounting change that is “material” to the bottom line should be footnoted in this manner. But…
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