Based on my auditing practice, I notice that often entrepreneurs do not clearly understand financial terms. It happens that some terms are replaced by others. Such a substitution of concepts can cause confusion in the calculation of financial indicators by entrepreneurs.
Our article will talk specifically about two indicators, both of them financial. These are income and revenue. Let’s start the review and figure out what the difference is between them.
The concept of income
In the economic and financial literature, income is defined as the receipt or increase in the economic benefits of an organization due to the receipt of assets (this can be cash, other property, improvement in the quality of property) or the repayment of liabilities that lead to an increase in the capital of this organization. This is the classic definition of income.
Any commercial organization strives to increase capital. In other words, the meaning of any organization is to make a profit, which leads to an increase in capital that belongs to the owners of this organization.
Income Examples
Income is a fairly broad concept. Let’s see what income can mean. The income will be:
- receipts or, so to speak, a reflection of revenue from customers;
- this may be the receipt of any other income, for example, from writing off accounts payable after the statute of limitations expires.
Here are some fairly classic examples of income. However, financial literature also treats such operations as revaluation of fixed assets as income. Here I can say that many entrepreneurs do not correlate operations on revaluation of fixed assets with income. However, this is the wrong approach. As a result of the revaluation of fixed assets, our assets and fixed assets increase, which in turn leads to an increase in capital and additional capital.
From a financial point of view, the revaluation of fixed assets is also income. This approach is especially relevant in the field of international finance.
Next, I propose to consider a clearer and narrower concept – revenue.
The concept of revenue
Revenue is income received as a result of the ordinary activities of an organization. From the definition it is clear that revenue in relation to income is a narrower concept. It turns out that revenue is income associated with the main activity of the organization.
An organization or entrepreneur begins to calculate the profit or loss of the current period from the first and most key indicator – this is the revenue indicator.
When accounting, the following are subtracted from the “revenue” indicator:
- cost;
- other expenses;
- taxes.
Other income and expenses are also taken into account. And, accordingly, the indicator of the financial result of the current period is displayed. This is either the profit or loss of the current period.
When can a receipt be classified as revenue
Basically, we figured out what revenue is. Now I would like to note such an important point as the correlation between the concept of “revenue” and the accrual method.
It is very important for an entrepreneur to understand that revenue is accounted for on an accrual basis. This means that we report transactions in the period in which they took place. Let’s take a closer look:
Some entrepreneurs, when receiving money from a buyer into their bank account for upcoming shipments, work, or services, believe that this is already revenue. However, this is not true.
The receipt of funds on account of upcoming deliveries, services or work is nothing more than an advance payment for goods, work or services that have not yet been actually transferred. In this case, there is no question of revenue recognition.
Therefore, in order to correctly determine the type of receipt, entrepreneurs need to separate concepts such as money received from the buyer and revenue, which they can recognize and reflect when forming their financial result.
Thus, not all cash inflows received as a result of the organization’s ordinary activities can be classified as revenue.
