Many financial statements types exist. And they each contain various line items that you should know to understand how a company performs. Among them are revenue and retained earnings.
Revenue and retained earnings both appear on a company's financial statement and can give you a sense of how the company is performing. The difference between them boils down to profit. In very simple terms, revenue represents money that comes in the company's door, while retained earnings represent the money that doesn't go back out.
What Is Company Revenue?
Revenue is the money a company primarily makes from its business activities – selling goods and services within a specified period.
Generally, the revenue that a company reports doesn't take any of its expenses into account. For example, if Willie's Widget Corp. sells a widget for $10, then that $10 is revenue, regardless of whether the widget cost $4, $10 or $20 to produce.
In business, "revenue" is sometimes just called "gross sales" – and it is not the same thing as "income." Income is what's left over after subtracting expenses from revenue. Revenue is one of the items on an income statement and usually appears at the beginning of the document. For that reason, it is sometimes referred to as the “top line” of a business.
Read More: How to Calculate Total Revenue Growth in Accounting?
Basics of Recognizing Revenue
The amount of revenue a company reports in any period does not necessarily equal the amount of cash that comes in the door during that time.
Publicly held companies keep track of their finances using the accrual method of accounting. In accrual accounting, businesses report revenue when they earn money at the time the transaction happens, not when they actually receive that money.
For example, Willie's Widget Corp. might fill an order for 5,000 widgets for $10 apiece, with payment due in six months. In that case, it records $50,000 in revenue immediately, because it has fulfilled its end of the deal. It has fully earned the money.
On the other hand, if Willie's Widgets accepts a $50,000 upfront payment for widgets to be delivered in six months, it can't record the revenue until it delivers the product – until it earns the money.
Read More: Why Are Income Statements Important?
What Are Retained Earnings?
A company's income statement starts with its revenue, or the "top line." It then deducts all the costs of doing business -- everything from raw materials to workers' salaries to interest on loans to taxes. The result is net income, known universally as the "bottom line." This is the company's profit for the year, also called its "earnings."
Many companies return a portion of this profit to their shareholders as a dividend, or a cash payment. Whatever it doesn't pay out in dividends, it keeps in the business as "retained earnings."
On the company's balance sheet, the retained earnings entry is the accumulated total of all the company's retained profits, minus its losses, since it opened for business.
Nature of Retained Earnings
As is the case with revenue, retained revenue does not necessarily equal cash on hand. Suppose Willie's Widgets has $1 million in retained earnings, all of it in cash, and the company decides to buy a new widget-making machine for $300,000.
In accounting terms, the company isn't really "spending" any of its retained earnings; it's simply converting $300,000 worth of it from cash into equipment. That $300,000 worth of value remains in the company, so the retained earnings don't change.
Later on, of course, the machine will lose value. As it does so, that "depreciation" will be reflected as a reduction in retained earnings.
Remember, a company can generate revenues and still make a net loss. On the other hand, retained earnings indicate the company has been profitable. Therefore, you need to understand the differences between retained earnings and revenue because they each show a different picture of how the company is performing and its financial position.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.