How To Calculate Revenue Realization Rate
Published on Tuesday, September 7, 2021
As we all know, measurements and metrics are extremely important for businesses to take note of. If you’re ignoring these things, you might be stifling your growth. The reason is simple. You cannot make things better if you do not have an understanding of the current circumstances.
This rule is true for everything in business. For instance, if you want to minimize complaints from customers, you need to know how many complaints you are getting per month. The same goes for the financial well-being of your organization. If you want it to be great, you need to know where you currently stand.
One of the metrics that you must keep your eye on when it comes to ensuring that your business is in good financial standing, is the revenue realization rate. In this article, we’ll tell you everything you need to know about the revenue realization rate. Read on to find out more!
What Is Revenue Realization Rate?
To understand what the revenue realization rate is, we will break the term down into its parts. Let’s begin with revenue.
Revenue is all the money that enters into your business as a result of making sales (on your products or services). The idea of revenue is not to be confused with income. Revenue is income before the deduction of expenses.
Then, you might wonder, what is revenue realization? Well, it’s not that difficult to understand. Essentially, revenue realization occurs once the revenue is recognized from the sale of a product or service. In other words, revenue realization is when a sale is converted into real revenue. (We should note that there is a difference between revenue realization and revenue recognition.)
As an example of revenue realization, consider this scenario. A SaaS company sold a deal in January for $3,600 in annual recurring revenue. The customer is to pay this on a monthly basis. But, there was a complication and the customer only started to get their product in March. As such, at the end of the year, the SaaS company will only realize $3,000 of its projected revenue from this deal.
So, following this, what is the revenue realization rate? In short, it is the percentage of the revenue that is actually recognized compared to what was expected. In other words, it is the proportion of what was actually recognized vs. what was originally booked or sold. Or, it is the difference between how much was billed and how much was forecasted to be billed in the original sale.
In our above example, the revenue realization rate for this SaaS deal would be 83.33% ($3,000 divided by $3,600). We’ll detail this calculation a little later!
Why Is Revenue Realization Rate Relevant?
The revenue realization rate of your business can give you an indication of the company’s profitability. For instance, if you have a very low rate of realization, it means that it will have a substantially negative impact on the profits you are bringing in (because the revenue coming in is less than it could or should be).
Furthermore, you can use the revenue realization rate metric (provided it is good) to identify where your company may be leaving money on the table and why your revenue isn’t growing as fast as you were expecting it to grow.
Overall, by considering the revenue realization rate of your company as a whole, you will have more insight into how and where to improve your revenue efforts. In the end, this will ensure the growth of your organization. This is what makes it relevant.
Calculating Revenue Realization Rate
The calculation for the revenue realization rate is fairly simple. Here are the basic steps:
(Actual Revenue Recognized)_/ (Total Revenue Estimated from a Sale of a Product or Service) x 100 = Revenue Realization Rate
As you can see, and as we mentioned earlier, the calculation essentially translates how well you are converting a sale into revenue.
Here is a very simple example to help you understand: Let’s say a supplier to an automobile manufacturer closes a deal worth potentially $10M a year in parts that will be sold. Since manufacturers recognize revenue when a product is actually shipped, the company ends up only shipping and selling $7M in parts over the course of the year, for a variety of reasons including vendor supply issues, production delays, and lower than initially expected demand.
The calculation for revenue realization will be the following:
Original Agreement / Sale: $10,000,000
Actual Product Shipped / Revenue Recognized: $7,000,000
Revenue Realization Rate = ( $7,000,000 / $10,000,000 ) X 100 = 70%
If you consistently see low revenue realization rates, it means that you are not getting paid for enough of your booked sales.
Tips For Improving Revenue Realization Rate
There are a variety of reasons your realization rate could be consistently low. If you find yourself in this position, you can take steps to improve your revenue realization rate.
First and foremost, you can set up a team whose purpose is to ensure that everyone remains accountable for responsibilities in terms of realizing revenue. Then, this team can also conduct analyses into where and why realization is low. By singling out where the issue is stemming from, they can then work on finding ways to improve.
Another way you can try to improve in this aspect is by setting standards within your organization. You could even request that managers approve bills before they are sent off, to ensure that potentially realizable revenue is not being written off unnecessarily. This takes us to the next tip – don’t under-bill if it’s not necessary.
Finally, you can attempt to make customer-facing improvements. For instance, you can take a look at which customers consistently yield low realization. From there you can try to figure out why that may be the case, and then make changes in pricing or how those customers are dealt with and how work is done for those customers. If it comes down to it, you may even give an ultimatum to those customers who prove to be unprofitable and difficult to deal with every month.
The revenue realization rate is an important metric for your organization to consider. It gives you insight into your weak spots, your profitability, and much more. And, with revVana, you can use this figure to project and plan your future! Contact us to get started today.