The term revenue often is misunderstood by investors. Revenue is money coming into a company. Yet even high-revenue companies can be poor investments.
Think of revenue like your paycheck every two weeks. It’s an okay number, but that doesn’t mean you’ll have any left after you pay the bills.
In fact, if you’re not careful, you might even be in debt by the end of the month.
In the same way, revenue is a company’s “paycheck,” the top-line number of the accounting sheet.
Revenue is quite simply all incoming cash from sales, the money paid by clients or customers for the goods or services the company produces.
From there, you have to subtract a number of costs, the “bills” a company must pay before declaring a profit.
Most immediately, there are costs of production: Raw materials, machinery, labor and labor benefits.
Companies must also account for long-term costs, such as financing the management may have arranged to invest in the business.
Then the company must pay taxes. If there are losses, companies can carry forward losses into future tax years.
Companies also deduct the cost of machinery, software and other business expenses against future taxes.
Once the company subtracts all of its costs from the top-line revenue number the last number on the sheet is profit, the bottom line.
In any given three-month period, this profit number might be positive, even or negative. Quarter to quarter, investors watch this number carefully.
If a company is growing fast a few quarters of negative numbers could be seen as a positive sign. So long as the revenue number is climbing and the costs are static or falling, profits cannot be far off.
If the company is growing investors tend to buy in regardless of the profit number at the moment. They see profits growing quickly in the months or years ahead.
If profits do begin to grow, then a rising revenue number is great news because at some point costs settle down. More revenue instantly becomes more profit.
Growing profit attracts more investors, pushing up the stock price and rewarding the patient, early investors who hung on during the negative quarters.
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