Managers and investors can use revenue analysis to evaluate a company’s financial health. Profitability-centric financial ratios measure revenue in terms of other financial factors to discover correlations and underlying causes for revenue fluctuation. Comparing financial ratios with previous performance helps an analyst discover internal change drivers. However, numbers should also be compared with industry averages to account for changes that affect the entire industry equally.
Account for Revenue Recognition
Before using revenue figures to analyze performance, an analyst should understand what’s in the revenue balance sheet account. A company’s revenue account is affected by their revenue recognition policy. Most companies try to recognize revenue regularly using the percentage-of-completion method. However, contracts must meet a variety of constantly changing accounting standards in order for the company to recognize project revenue. Often, companies are only allowed to recognize revenue once a contract is complete, even if they’ve been regularly incurring project costs. The completed contract method can artificially lower revenue levels during the life of the contract and artificially boost revenue when the project is done.
Return on Revenue
More revenue doesn’t necessarily mean a company is performing better. If rising costs exceed rising revenue, it could mean the company’s operations are unsustainable. Return on revenue measures revenue in terms of sales to isolate changes in costs. To calculate return on revenue, divide net income by revenue. For example, a company with $500 of net income and $1,000 in revenue (500/1000) has a return of 0.5, or 50 percent. An increasing number means the company is doing a better job at retaining profit.
Revenue Per Employee
Just because company revenue increased doesn’t mean employees deserve a bonus. The revenue-per-employee ratio measures sales per employee to evaluate human resources performance. To calculate revenue per employee, divide sales revenue by the number of employees in the company. For example, a company with $6,000 in sales and 10 employees (6,000/10) has a ratio of 600. Keep in mind that certain industries such as technology tend to be less labor-intensive and realize higher sales per employee. Fledgling companies tend to have low revenue-per-employee ratios until they’re established in their industry.
In addition to evaluating performance, analysts can use revenue data to improve company operations. Marginal revenue measures the increase in revenue from selling an additional unit of output. For example, if a company can sell one product for $10 and two products for $18, the second product has a margin revenue of $8. Managers can analyze marginal revenue and marginal costs to choose the most profitable mix of products and services.