One of the most common improvement opportunities we see with new clients is related to how they report their revenue.
When you’re first starting your business, your primary objective is usually “Make Money!”. This is one of the most difficult things to do. Go from zero to one. If you can make it here, congratulations! Your next challenge is optimising and growing. Here are some tips on how reporting revenue can help.
Segment Your Revenues
You should double down on your most popular and most profitable services or products, and your most valuable customers.
First take a look at what services you’re providing. What are the important differences? Maybe you own a service company that does consulting but also runs workshops. Maybe you have a SAAS business with multiple pricing tiers. In reviewing your revenue you’ll find your customers have some common differences:
- Level of Service
- Product Type
- Customer Demographics
- Service Duration
This will vary from business to business. Determine what are the most important differences to you.
Recognise Revenue When Service is Delivered
An important aspect in financial reporting is “Revenue Recognition”. This is the justification for saying money I made counts as a sale. An easy way to think about this is:
“Cash in” does NOT equal “sales.”
Sales should be recognized when you actually deliver your service or product. Let’s say you own a company which produces women’s jewellery. You get an order from a large department store chain who places an order and pays you £100,000. You received £100,000 in cash. However, you can’t recognize that cash until you manufacture and deliver the jewellery to the customer.
This can be particularly tricky when your service is delivered over an extended period.
Let’s say you own a consulting business and you’re contracted for the next 12 months for £120,000. You invoice the client for the full amount today. They may even pay you up front for it. So, you have £120,000 cash in the bank. We see many companies who will then show that £120,000 as sales for that month. Unfortunately, you haven’t delivered the service yet. To accurately report that revenue you should spread it evenly over the 12 months of service.
For subscription businesses the same rule applies: Sales on annual subscriptions should be spread over a 12-month period. These rules are particularly important if you are raising money. Reporting sales up front means you are over stating your revenues. This doesn’t look very good to potential investors.
Know the Unit Economics of Each Revenue Segment
You’ve now segmented your revenue and recognized it during the correct period. Now the fun part. Which of these segments is the most profitable or has the most potential. A first step in this process to:
Know your Gross Margin for Each Revenue Segment
Gross Margin = Sales from a revenue segment minus the cost to deliver that service.
The cost to deliver your service varies from business type. If you’re not sure which costs these are they may include:
- Manufacturing: Raw materials, assembly and distribution
- Service: Cost of service labour and related expenses
- Software: Hosting fees, a portion of product development and customer support
Just like revenue, recognize expenses when the service or product is delivered.
Example: If you have a service business that delivers £10,000 of service in a month and you paid the service delivery staff £6,000 to deliver you would have a Gross Profit of £4,000. This equates to a Gross Profit margin of 40% (£4,000/£10,000). You’ll ideally calculate this number for each revenue segment.
The benchmark for how profitable your gross margins should be varies significantly depending on business type and industry. In the examples given some ranges you could expect for gross margins would be:
- Manufacturing: 20%-50%
- Service: 30%-60%
- Software: 70%-90%
Now that you have accurate gross margins you can drive some meaningful insights into your business. Knowing gross margins will keep you focused on the products or services with the most potential. It will also allow you to speak confidently about your business to potential investors.