Understand Your P&L Statement: Sales vs. Revenue
Originally published: 03.01.15 by Ruth King
Sales are critical to survival — when revenue is actually generated is even more critical.
Starting this month I'll "tear apart" the profit and loss statement (P&L) so you can make sure your monthly P&Ls are giving you the information you need to make great business decisions.
Let's start by focusing on sales and revenue. Although many contractors use these two terms interchangeably, they actually mean different things. They're also accounted for differently. Sales are not shown on a P&L; revenues are.
A sale occurs when a customer says, Yes, I want to purchase the equipment/service/project you proposed." This could be, for example, the acceptance of a $12 million mechanical project proposal, a residential replacement system proposal acceptance or a service technician educating your customer about a residential maintenance agreement.
A sale occurs when the customer says yes; revenue occurs when the work is done.
Revenue is that portion of the sale performed in a specific month. Revenue is shown on a P&L. You could have a $12 million sale and recognize $1 million in revenue for the month of March.
Likewise, your residential customer said yes and paid your company for a year's maintenance plan in January. You had a sale of $180, for example, but no revenue since the first maintenance won't be performed until April. The sale is deferred income in January.
This is recorded in the current liabilities section of your balance sheet. Your company receives revenue of $90 in April when the first maintenance is performed and receives another $90 in revenue in October when the second maintenance is performed — $90 goes on your P&L in both April and October.
The cash you receive for that maintenance plan should go into a separate, interest bearing account when it's received. It's not your money until you perform the work. You have a liability to perform and should the customer want her money back before maintenance is performed, she is then owed the money.
If you want to take the money out of the savings account and put it in your operating account when you perform the maintenances, you can since you've earned the revenue.
From a service perspective, sales and revenue are almost identical. The service technician recommends work to the customer, the customer says yes, he does the work and the customer pays (residentially) or an invoice is created (commercial). Revenue is recognized when the sale is made.
From a system replacement perspective, sales and revenue are usually earned close to the same time. Generally, your sales people close a sale and the system is installed the next day or within a few days.
You've probably had a customer cancel the sale before the installation date. If the sale was already entered into your accounting system, it has to be deleted. This is another reason to recognize revenue, not the sale.
The only time recognizing revenue becomes a little tricky is at the end of the month. If a sale is made and the system is not going to be installed until the next month, you cannot recognize the revenue for that sale until the following month. This means the sales person's monthly sales might be different than the sales person's monthly revenue. Pay commission on revenue, not sales.
If you install large commercial or even residential jobs, generally, work in process is a line item in the current assets portion of your balance sheet. Your company accounts for the revenue on your P&L according to how your books are set up (either completed project or percentage of completion).
Sales and revenues are generally vastly different. The sale could be huge where the project could take years to complete. The revenue and expenses against that revenue are recognized on your P&L as the project progresses.
Sales are critical to survival — when revenue is actually generated is even more critical. Make sure revenue is stated on your P&L, rather than a sale, which could be cancelled. When you are recognizing revenue, rather than sales, you know the top part of your P&L statement is correct.
Ruth King is president of HVAC Channel TV and holds a Class II (unrestricted) contractors license in Georgia. She has more than 25 years of experience in the HVACR industry, working with contractors, distributors and manufacturers to help grow their companies and make them profitable. Contact her at email@example.com or call 770-729-0258.