What revenue of a company means?

Revenue is the total gross amount of money generated by a business's operations during a financial period. Revenue is the first amount seen on a company's income statement; all expenses are deducted from it to calculate the company's net income.

Non-operating amounts  -- interest income proceeds from a lawsuit or gains on the sale of equipment or other assets -- aren't typically included in revenue.

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Determining which sales should be based on operations should be straightforward. For example, McDonald's (NYSE:MCD) revenue would include all of the money it obtains from selling hamburgers but none of the money it receives from the bank as interest from a savings account.

Revenue is often referred to as sales -- or the "top line." Identifying a stock's revenue and revenue growth is a big part of stock analysis. Let's go over the differences between revenue and a few other common measures of income and some examples of revenue.

Revenue vs. net income

Where revenue is the top line of the income statement, net income is the bottom line. After all expenses are deducted from revenue, net income is what's left over. Let's take a look at a typical income statement.

Table by author.

The first deduction from revenue is cost of goods sold to calculate the gross margin. Cost of goods sold is the direct/variable cost of sales for the company. For a retail business, it is the cost of the inventory sold by the business. For a construction company, it is the cost of materials and labor on the job site. A company's gross income, or gross margin, is indicative of how much it is able to mark up its products.

Next, we deduct operating expenses, which are commonly referred to as overhead. Operating expenses are generally indirect (meaning not directly related to the sale of goods or services) and fixed costs. These are expenses such as rent, utilities, administrative wages, and other maintenance items. Operating income shows you how much the business has netted from its core operations minus all its direct and overhead costs.

Finally, we subtract other income and expenses to find net income. Other income and expenses include legal settlements, interest income, and gains or losses from the sale of assets that represent money coming into or going out of the business but aren't considered routine or aren't a result of the company's core operations.

Revenue vs. cash flow

One of the first things you need to know about financial statements is accrual accounting. Public companies in the U.S. are required by generally accepted accounting principles (GAAP) to use accrual accounting.

It's a simple concept: Instead of booking revenue and expenses when cash actually changes hands, they're booked when earned or incurred.

For example, if a construction company buys 17 doors on account from its door supplier, it will book the expense for the doors right then, and the door supplier will book revenue for the sale. The construction company then has an account payable (AP) to the door supplier, and the supplier has an account receivable (AR) from the construction company. Cash may not change hands for months, depending on the terms of the sale, but each company reports the transaction on their respective income statements when the doors are delivered to the job site.

Accrual accounting makes intuitive sense. You want expenses and revenue to match the financial period when they actually happen. Suppliers may offer generous terms that allow businesses to wait months to pay, but the economic reality of the business is that it incurred an expense.

That said, it is also useful (and, according to some investors, imperative) to evaluate the true cash flow of a company. If a business is offering crazy AR terms to its customers to juice sales, you want to know if it has the cash flow to fulfill the orders.

There are ways to manipulate revenue and net income and still stay within the rules of GAAP, but true cash flow can't be manipulated outside of fraudulent activity.

Let's conclude with an example of revenue from McDonald's recent financial statements. You can find the company's annual revenue in its SEC Form 10-K and its quarterly numbers in its Form 10-Q. Let's start with the 10-Q for the period ending Sept. 30, 2021.

Revenues are reported on the income statement, which is called the Condensed Consolidated Statement of Income on this report. For 2021, McDonald's had $6.2 billion in total revenues, and $2.6 billion came from sales at company-owned restaurants. Another $3.5 billion came from franchise fees from non-company-owned restaurants, and about $100 million came from various other sources.

We can compare that to the other numbers we've discussed. Cost of goods sold (the cost of hamburgers and direct costs related to franchise occupancy) brings revenue down to a gross profit of $3.5 billion. After that, operating expenses came in at around $500 million, putting operating income just under $3 billion (most of McDonald's expenses are direct revenue-related expenses).

Finally, other expenses, including tax and interest expenses, brought net income to $2.1 billion. Cash flow wound up at $2.6 billion because of the addition of almost $500 million of depreciation.

Related investing topics

Revenue is key to stock analysis

The type of long-term investing that we do at The Motley Fool starts with proper fundamental analysis of a company's financial statements and growth prospects. The first step in that analysis is understanding revenue and how it ties to both net income and cash flow. Once you have that level of understanding, you can move on to a more exciting part of fundamental analysis: valuing stocks.

Mike Price has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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