Revenue and Gross Profit#

Revenue is where value creation begins. Understanding how to analyze a company's top line and gross profit margin is essential for evaluating any business.

Revenue isn't just "money coming in." It's specifically earned income from a company's primary business activities. Interest income, asset sales, and other non-core sources are typically reported separately.

Understanding Revenue Recognition#

When does a sale count as revenue? This is more complex than it seems.

The Key Principle#

Under accounting rules, revenue is recognized when:

A product is delivered or service is performed
The price is fixed or determinable
Collection is reasonably assured

Watch Out

Aggressive revenue recognition is one of the most common accounting tricks. A company might record revenue before goods are shipped or services are truly complete.

Revenue Recognition Examples#

Scenario	When Revenue is Recognized
Product sold and shipped	When product ships/delivers
Subscription service	Spread over the subscription period
Long-term contract	As work progresses (percentage-of-completion)
Gift card sold	When the card is redeemed
Software license	Depends on terms—often upfront or over time

Analyzing Revenue Growth#

Revenue growth tells you whether the company is expanding or contracting. Here's how to analyze it:

Year-over-Year (YoY) Growth#

Compare the same quarter or year to the prior period:

YoY Growth = (Current Period - Prior Period) ÷ Prior Period × 100

Example:

Q3 2024 Revenue: $120 million
Q3 2023 Revenue: $100 million
YoY Growth: ($120M - $100M) ÷ $100M = 20%

What to Look For#

Signal	What It Suggests
Consistent growth	Healthy, expanding business
Accelerating growth	Business gaining momentum
Decelerating growth	Potential concerns, maturing market
Negative growth	Problems that need investigation

Context Matters

A company growing revenue at 10% might sound modest, but context matters. A $500 billion company growing 10% is adding $50 billion in sales—impressive! A small startup growing only 10% might be struggling.

Organic vs. Inorganic Growth#

Not all revenue growth is created equal:

Type	What It Means	Why It Matters
Organic Growth	Growth from existing business	Shows underlying business strength
Inorganic Growth	Growth from acquisitions	May not be sustainable

If a company grew revenue 50% but acquired a company that added 40%, the organic growth is only about 10%. Always check for acquisitions when analyzing big revenue jumps.

Revenue Mix#

Understanding where revenue comes from adds valuable context:

By Product/Service#

Which products are growing fastest?
Is the company dependent on one product?
Are new products gaining traction?

By Geography#

Domestic vs. international split
Which regions are growing?
Currency effects on international revenue

By Customer Type#

How concentrated are customers?
Is one customer a big percentage of revenue?
Recurring vs. one-time revenue

Customer Concentration Risk

If one customer represents more than 10-15% of revenue, the company faces significant risk if that customer leaves. Companies must disclose major customers in their filings.

Understanding Gross Profit#

Gross profit reveals the fundamental economics of what a company sells:

Gross Profit = Revenue - Cost of Goods Sold

What COGS Includes#

Business Type	Typical COGS Components
Manufacturer	Materials, direct labor, factory overhead
Software	Hosting, data centers, customer support
Retailer	Inventory costs, shipping to stores
Consulting	Consultant salaries, project costs

Gross Margin Analysis#

Gross Margin = (Gross Profit ÷ Revenue) × 100

Industry	Typical Gross Margin
Software (SaaS)	70-85%
Consumer Products	30-50%
Retail (Grocery)	20-30%
Manufacturing	25-40%
Airlines	15-30%

Higher gross margins aren't always "better." A grocery store with a 25% margin can still be a great business with high volume. Compare margins within the same industry.

Gross Margin Trends#

Changes in gross margin over time tell an important story:

Improving Margins Might Mean:#

Better pricing power
Lower input costs
Economies of scale
Shift to higher-margin products

Declining Margins Might Mean:#

Increased competition
Rising input costs
Discounting to maintain sales
Shift to lower-margin products

Example Analysis#

Year	Revenue	COGS	Gross Profit	Gross Margin
2022	$100M	$55M	$45M	45.0%
2023	$120M	$64M	$56M	46.7%
2024	$150M	$78M	$72M	48.0%

This company shows healthy signs: growing revenue AND improving gross margin. The business is scaling efficiently.

Red Flags to Watch#

Revenue Red Flags#

Sudden revenue spike without clear explanation
Revenue growing much faster than the industry
Large "adjustments" to previously reported revenue
Growing faster than accounts receivable

Gross Margin Red Flags#

Sharp decline in gross margin
Margin significantly below competitors
Inconsistent margins quarter to quarter
Improvement that doesn't make business sense

Too Good to Be True

If revenue or margins look unusually good compared to competitors, dig deeper. There might be accounting choices that flatter the numbers—or worse, manipulation.

Key Takeaways

Revenue recognition rules determine when sales count—timing matters
Analyze revenue growth both year-over-year and sequentially
Distinguish between organic growth and growth from acquisitions
Gross margin shows the fundamental profitability of what a company sells
Compare gross margins to industry peers, not across different industries
Watch for trends—improving margins suggest business strength
Be alert to red flags like sudden spikes or unusually high margins