In this article, we are going to discuss the concept of “real revenue” and how it can be applied to various businesses. The idea of real revenue can be somewhat complex, but with a detailed explanation and practical examples, you’ll gain a better understanding of what it means and how to use it in your business. This content is inspired by a conversation between Mike Michalowicz and his colleague Kelsey Ayers on the channel Mike Michalowicz.
What Is Real Revenue?
Real revenue is an adjustment made to the actual top-line revenue of a business to reflect what the business truly generates from its activities. It’s a critical concept, especially for those in manufacturing or businesses that involve significant subcontractors and materials costs.
Key Points:
- Understanding the Basics: Real revenue takes into account the money you spend on materials and subcontractors, separating it from the actual work you generate.
- Application in Different Industries: Real revenue is particularly relevant for industries like house building or jewelry manufacturing, where there are substantial costs for materials and subcontractors.
- Service-Based Business Considerations: If you provide a service-based business, your top-line revenue is typically your real revenue, and no adjustments are needed.
Example:
If you’re a house builder making $1 million a year but spend $250,000 on materials and another $250,000 on subcontractors, then your real revenue would be $500,000. The other $500,000 is merely managing the dispersion of money to other entities, such as suppliers.
Why Is Real Revenue Important?
Real revenue allows a business to understand its actual size and operate accordingly. It helps in:
- Aligning Business Operations: Understanding the real revenue helps in running the business at the right scale. For instance, a home builder with a $50 million top-line revenue but a real revenue of $20 million needs to operate as a $20 million business.
- Creating an Even Playing Field: Real revenue adjustment helps put all businesses on the same footing, irrespective of the industry.
- Improving Decision Making: It aids in decision-making processes, especially when it comes to understanding profitability and cost management.
How to Apply Real Revenue to Your Business
Applying real revenue to your business depends on the nature of your operations:
- Identify Costs: Determine the costs related to materials and subcontractors.
- Make Adjustments: Subtract these costs from your top-line revenue to find the real revenue.
- Analyze and Apply: Use the real revenue figure to make informed decisions about your business’s operation.
Conclusion
Understanding what real revenue is and how to apply it is essential for businesses that deal with substantial costs for materials and subcontractors. It provides a realistic picture of the money generated from activities and helps in making informed business decisions. Applying real revenue to your business model could lead to a more transparent and fair understanding of your financial situation, and this guide should provide you with the tools to do just that.
Resources:
- Profit First: A financial management concept that emphasizes understanding and applying real revenue.
- Materials and Subcontractors: Understanding these expenses is crucial for calculating real revenue.
By comprehending and utilizing real revenue, you’ll be better equipped to assess your business’s true performance and make sound decisions that align with your actual operational scale. Feel free to explore more about this concept and how it can be applied to different business models, as it’s one of the core ideas that could transform your understanding of profit and revenue management.