Total Revenue or Sales
Investing Lesson 4: Analyzing an Income Statement
The first line on any income statement or profit and loss statement is an entry called total revenue or total sales. This figure is the amount of money a business brought in during the time period covered by the income statement. It has nothing to do with profit. If you owned a pizza parlor and sold 10 pizzas for $10 each, you would record $100 of revenue regardless of your profit or loss. If you owned a furniture store and sold a bedroom set for $25,000, you would record $25,000 regardless of your profit or loss.
If you owned a hamburger joint and sold 100 cheeseburgers for $3.99 each, you'd record $399 in revenue regardless of your profit or loss.
The total revenue figure is important because a business must bring in money to turn a profit. If a company has less revenue, all else being equal, it's going to make less money. For start-up companies that have yet to turn a profit, revenue can sometimes serve as a gauge of potential profitability in the future.
Many companies break revenue or sales up into categories to clarify how much was generated by each division. Clearly defined and separate revenue sources can make analyzing an income statement much easier. It allows more accurate predictions of future growth. When I first wrote this investing lesson 14 or 15 years ago, I originally shared a copy of the Starbucks 2001 income statement with you, saying it was an excellent example. It is reproduced at the bottom of this page in Table STAR-1.
(If you really want to get a kick, go check out the total sales figures for Starbucks as of the most recent year ended 2015 in its annual report or Form 10-K filing. For those of you who don't mind me sharing the punchline, revenue grew to $15,197,300,000 over that span. In fact, a $100,000 investment at the time this lesson was originally published until today, in March of 2016, would have grown into more than $1,071,000 on a total return basis.
That doesn't even assume you reinvested your dividends. For Starbucks, exponentially growing sales also meant exponentially growing profits — something that isn't necessarily true at all firms — and the owners were richly rewarded for their patience, enjoying a CAGR about which most people could only dream.)
As you see in the original, archived 2001 chart at the bottom of this page, sales at Starbucks came primarily from two sources: retail and specialty. In the annual report, management explains the difference between the two several pages before the income statement. "Retail" revenues refer to sales made at company-owned Starbucks stores across the world. Every time you walk in and order your favorite coffee, you are adding $3 to $5 in revenue to the company's books. "Specialty" operations, on the other hand, consists of money the company brings in by sales to "wholesale accounts and licensees, royalty and license fee income and sales through its direct-to-consumer business". In other words, the specialty division includes money the business receives from coffee sales made directly to customers through its website or catalog, along with licensing fees generated by companies such as Barnes and Noble, which pay for the right to operate Starbucks locations in their bookstores.
From the perspective of an owner, there is often a mistaken belief that growing sales are always a good thing. While this is generally true, there can be exceptions. In an industry such as property and casualty insurance, growth is almost always achieved by lowering policy costs, which can hit profits hard if management isn't careful, though it may not show up for several years as there is a delay between when the policy is priced and when the losses are incurred. Likewise, if growth is financed by diluting existing stockholders, taking on excessive amounts of debt, or engaging in riskier activities, it can result in a partial or total wipe-out down the line. History is full of companies that are cautionary tales, from former blue chip banks and thrifts such as Wachovia and Washington Mutual, insurance conglomerates such as AIG, and investment banks such as Lehman Brothers and Merrill Lynch.
Growth in sales or revenue should not be the goal by itself. Growth in profitable sales and revenue, adjusted for risk, and in a way that rewards the existing owners, is the objective. As you learn more about the income statement, this will make more sense. The short version is that you should only want a business to generate more sales if it is going to benefit you in some capacity over the long-run. After all, it's your hard-earned money that is at risk in the enterprise.
Depending upon the business and its economics, the revenue or sales figure on the income statement may be reduced by what is known as a "reserve for allowance of returns". What that means is a business that knows, traditionally, 1 percent of its sales end up being returned by customers might go ahead and include that 1 percent reduction in the revenue figure as that is what experience shows is likely to happen. When your financial analysis skills become more advanced, you will need to study these five methods of revenue recognition management can use to smooth the way they report sales.
Table STAR-1 (Archived Illustration from Original Investing Lesson — See Text for Explanation)
For nostalgia's sake, let's use the archived sales/revenue figures from the original article I wrote almost two decades ago. You can easily replace these with figures from Starbuck's current 10-K filing or annual report. In fact, I'd encourage you to try as it will allow you to practice finding and researching financial disclosures.
|Archived Starbucks Coffee|
Consolidated Statement of Earnings - Excerpt
Page 29, 2001 Annual Report
In thousands except earnings per share
|Fiscal year ended||Sept 30, 2001||Oct 1, 2000|
|Total net revenues||$2,648,980||$2,177,614|