Revenue Definition, and Concept of Average Revenue, Marginal Revenue, and Other Terms in Economics

Definition of Revenue:

According to the International Financial Reporting Standards (IFRS), Revenue is the inflow of economic benefits arising during the ordinary course of an entity's economic activities.

The inflows should directly come from its product-selling activities or services rendered. They should not include other income.

According to the above definition, Revenue = Gross Receipts from sales or services. Other receipts like interest, royalties, and rents (which are not part of their core business) are treated as Misc. Income/Receipts.

Revenue is also referred to as Gross Income or Gross Receipts.

Generally, revenue is measured as receipts accrued for sales or services performed during a specific period of time - say, a particular week, a particular month, or a year. It is irrespective of whether payment is received during that same period or not.

IFRS Definition vs Accounting Concept of Revenue:

But, for accounting purposes, while preparing the Profit and Loss/ Balance Sheets, or Revenue Budgets, all types of income are considered as revenue. So, an accountant takes receipts from the sale of assets, interest received from banks, and rent receipts, etc., as Revenue in his books.

Revenue is the income of a business enterprise or any other organisations or governments. Revenue may be either in shape of sales proceeds from goods and services sold or in shape of receipts from other activities and sources of any enterprise or government. So, revenue includes sales income, fees received for services, interests received from investments and receipts from other sources like collection of taxes, duties, etc. It can include even donations received from others, funds received from other social activities, etc. All these receipts are collectively known as revenue.

Different types of revenue in economics
Sometimes, revenue can be referred to as business revenue, government revenue or association revenue based on the nature of organisation or enterprise.

Business Revenue

Business revenue refers to income or receipts from normal business activities of any organisation. Any type of business that indulges in manufacturing and / or selling of products, or in providing services to its clients receives income either in form of sales or as fees for services. This income is known as 'business revenue'. The main point is that the income should be from their prime business activity. If one is indulged in rental business, then his business income is the rent received. If it is a financial institution, then their income will be from interest and other charges received in lending the loans.

This business revenue can be classified into two parts as Sales income and other income.

Sales Revenue or sales income
Sales revenue denotes the income received by way of sales of goods or services. For a manufacturer, it is income from sales of produced goods. For a grocery or merchant, it is income from sale of provisions or merchandise. For a banker, it can be the sale of loans. To a service provider like consultant or barber or cobbler, it is their service charges received. So, the sales revenue is the main business income.

Other Revenue or other income
While performing a business, it is possible that you may receive some income which is not related to your primary business activity. For example, you are running a manufacturing business. You sell your produce and receive the revenue. Now, you may not be spending all that income for your business. You may deposit some money in fixed deposits or invest in other investments. So, you will be receiving interest from these investments. It is not your sale income. It is to be termed as 'other income'. Similarly, you may sell some old machinery or assets and buy new ones. This sale of old assets is not your primary sale. It is your 'other income'.If you can rent a part of your building or any machinery to others for a short period, the rent received is also treated as 'other income'.

Government Revenue

Government revenue is entirely different from business revenue. Government revenue is the money received from various taxes and duties imposed by the government to meet out its expenditure in running the government and on spending in various development programmes of the country.
The receipts include collections from Income Tax, Goods and Service Tax, Sales Tax, etc. and from duties like Customs Duty, Excise Duty, Export / Import Duty, etc. The government revenue may also include income generated through financial and banking operations and through railways and tourism departments. All these are part of government revenue intended for spending on public works and for welfare of the country.

Association revenue (Social & non-profit organisations)

Association revenue is that type of revenue generated by non-profit organisations and public associations like cooperatives and NGOs. It is a fund created through non-business oriented activities for a common cause of the members of the organisation or for public welfare. The revenue generated includes membership fees of members, donations or charity fund received from outsiders and any financial help received from governments, etc. They may also generate revenue through sponsoring of cultural or any kind of programmes.

Concepts of Total Revenue, Average Revenue and Marginal Revenue

Now, let us study another classification of revenue as total revenue, average revenue and marginal revenue.

Total Revenue

Total revenue refers to the total receipts or income made in business during a period. It is the whole/gross income from the sale of goods and services and does not include other receipts. But normally, it is treated as the product of quantity sold multiplied by the price per unit sold.

So, Total Revenue = Total quantity multiplied by cost per unit.
It can be represented as TR = Q*P, where TR is total revenue, Q is quantity sold, and P is the price per unit.

Average Revenue

Average revenue is the revenue or cost per unit of production or sales.

 

Generally, businessmen arrive at the average revenue by calculating the per-unit average of total expenses incurred in producing their output, which includes the value of their own minimum profit and other expenses like remuneration for staff and management. 

So they have to recover this average price through sales. The price is fixed by them accordingly. So, in most cases, the average revenue will be equal to the average cost of that product. Only then can they realize the full production cost.

Average revenue is calculated by dividing the total revenue by the number of units sold.

Average revenue = Total revenue / total quantity sold
AR = TR/ Q, where TR is total revenue and Q is quantity sold.

But we have already noticed that TR is Q*P as per our Total Revenue concept.

So, if we substitute TR with Q*P, then AR = Q*P / Q = P.

 

So, AR is the same as P. This is applicable in most of the cases.

Marginal revenue

Marginal revenue is the amount of revenue received by selling one more unit of the product. It is the change in revenue divided by the change in quantity sold.

Under normal circumstances, if cost or price remains constant, then Marginal revenue should equal Average revenue. But, in most cases, it is not so.

It is because if there is plenty of supply, the prices will fall naturally. On the other hand, if there is a shortage of goods, people tend to pay more for them rather than forgo them. 

So, Marginal Revenue cannot be equal to Average Revenue.

This is why the need for the concept of Marginal revenue arose.

Marginal Revenue is calculated by subtracting the extra revenue from the total revenue.

Marginal revenue = P*(Q+1) - P*Q, where P is the price or cost per unit, and Q is the quantity.

So, MR = the revenue received by selling (Q+1) units minus the revenue received by selling Q units.

For example, if a vendor sells each pair of slippers at Rs.100 per unit and suppose he sold 20 units on one day and 21 units the next day. 

If you want to know your marginal revenue for the next day, on the second day he sold one extra unit. First day TR was 100*20 = 2000, and second day's TR was 100*21 = 2100. His MR for the second day is Rs.100. 

 But we are not concerned with the additional revenue if the price remains the same.

Marginal revenue makes sense only when prices keep escalating.

Suppose he sold 20 units for 100/per unit on the first day. 

The next day, he was able to sell 21 units and earned only Rs.2080 as he had to sell the extra unit at a lower price. 

Therefore, MR will be only Rs.80, because he earned an extra amount of only 80 (2080- 2000 = 80).

Key Facts about Average Revenue and Marginal Revenue

• Average revenue (AR) or Marginal revenue (MR) can increase or decrease depending on circumstances.
• If fewer units are produced, AR will increase because many costs are fixed regardless of quantity, so the price per unit will be higher. Conversely, if more units are produced, AR per unit will be lower.
• Similarly, MR changes with quantity at certain levels. If more units are sold beyond a certain point, marginal revenue per unit will continue to decrease. If fewer units are sold than the market demands, MR may increase per unit sold.
• Average Revenue is calculated at a particular level of sales to determine the average price realized and to compare the cost price with the sale price.
• Marginal Revenue is calculated to study the impact of selling each additional unit. It is used to control sales volume and maintain price.
• AR and MR will be the same as long as the seller can maintain the same sale price for any volume of sales.
• If the seller is unable to maintain the same price at each level of sales quantity, then AR and MR will vary.