Average Revenue Formula

EconomicsArticles / Tutorial Titles

Introduction

Revenue is the total money earned by an organization within a specific period of time. Average revenue refers to the mathematical average of revenue earned per unit or individual. Average revenue provides information about the revenue earned by every unit and hence it shows the nature of revenues earned.

The average revenue per unit or user (ARPU) also lets analysts forecast the future price and profitability of the products. As prices are guided by profitability, the ARPU is an indicator of unit price and per unit profit which can be used to analyze future aspects of the company.

What is Average Revenue?

Average revenue is the statistical or mathematical average of revenue earned per unit or per user. The average revenue per unit or user (ARPU) permits a company's investors or management to check the revenue generation capability. This can help them forecast the future growth of a company. Although ARPU is an important measure, it doesn’t directly provide any straightforward information about the units to the user base.

However, ARPU is also a tool for the marketing team to set the correct prices of the products manufactured by a company. By understanding the nature of ARPU, the marketing team can determine the right prices of the products that will be accepted readily by the consumers in the market. Therefore, the average revenue formula that helps in determining average revenues is helpful in many dimensions of business and economics.

In the case of a one-product company that sells only at one price, the average revenue of that company's products is the unit price of the product. In such circumstances, the terms average revenue and price are synonyms.

However, if a company sells two or more products at two or more different prices, the average revenue provides information about the company's profits. In this case, ARPU denotes the average price of the units or users.

The two other factors related closely to average revenue are −

  • Marginal Revenue and
  • Total Revenue.

Total Revenue − This refers to the entire amount of money earned by a company due to the sale of a product or service. The price of a product or service must be multiplied by the quantity to get the total revenue.

Marginal Revenue − Marginal revenue refers to the change in total revenue due to the sale of one additional unit of a good or service. The marginal revenue can be stated as the rate of change of the total revenue.

Average Revenue Formula and its Importance

The average revenue formula is used by companies and analysts to analyze and forecast their revenue.

The average revenue formula is as follows −

$\mathrm{AR = \frac{TR}{Q}}$

$\mathrm{Average\: revenue = \frac{Total\: revenue}{Quantity\: of\: Units\: or\: Users}}$

Example

Telecom companies may use ARPU on a monthly basis. The cell phone carriers usually use the average revenue formula to measure and track the amount of revenue earned from every cell phone user.

Cable companies calculate ARPU for their subscription users and use the data internally. These data can also be used externally as a comparison to other companies and to forecast future revenue. Social media platforms, on the other hand, use average revenue to explain the gaps in valuation, track the sources of revenue and report the performance to investors.

How to Calculate Average Revenue?

In calculating the average revenue, the total amount of revenue is divided by the number of units or users during a given time period. The number of units or users may vary during the given time period, so the number of units or users can be estimated, or a weighted average is used, to provide the most accurate calculation possible. ARPU can be represented as a currency amount, Rupee, a table, or on a curve.

Here are the steps for calculating average revenue −

Data Collection

Data collection is the first step in calculating the average revenue. The data should be collected over a specific period in time. For example, if a firm wants to calculate the average revenue per unit for the last week, it must have the total weekly revenue for unit sales. Let’s consider, that the company sold four units in the last week, its revenue data might look like this −

Unit 1 = Rs 20,000

Unit 2 = Rs 30,000

Unit 3 = Rs 16,000

Unit 4 = Rs 24,000

Adding the data points

Now the total revenue must be calculated. The total revenue amount can be found by adding the four unit amounts together −

Rs 20,000 + Rs 30,000 + Rs 16,000 + Rs 24,000 = Rs 90,000

Dividing by the number of data points

There are four data points here, one for each unit. The total revenue of Rs90,000 and the four data points can be used to calculate the average revenue formula −

$\mathrm{AR = \frac{TR}{Q}}$

$\mathrm{AR = \frac{Rs\:90000}{4}}$

AR = Rs 22, 500

Analyzing the results

The average revenue per unit (ARPU) of the company for the last week was Rs 22,500. This information can be used to analyze the revenue further or make forecasting projections.

Market Structure and Average Revenue

There are four market structures, namely −

  • Perfect Competition
  • Monopoly
  • Monopolistic Competition
  • Oligopoly.

The relation between the number of goods produced and the average revenue is determined by one of these. In a perfectly competitive market, the average revenue is equal to the price and also equal to marginal revenue.

In the other market structures, the average revenue is greater than the marginal revenue and price. In general, the larger the quantity of output, the more will be the price and marginal revenue will decrease, which shows the market control of the company.

Conclusion

Average revenue is important information for all firms. The companies can understand the per unit revenue or per customer earnings using the average revenue formula. This is direct information for calculating the average profit of the company. This is important because firms must know what they are getting per unit against the production cost of one unit to check whether the products are sold in a certain bracket of pricing.

An average revenue formula is a great tool for finance as well as economics. While ARPU is used to determine the present and future conditions in finance, in economics, it shows the nature of demand in the market. By knowing and using the ARPU investors can determine the strength of a company to earn profits. This helps them to find strong companies that can offer them greater returns in the future.

FAQs

Qns 1. What is the formula to calculate the average revenue?

Ans. The average revenue formula is −

$\mathrm{Average\: revenue = \frac{Total\: Revenue}{Quantity\: of \:Units\: or\: Users}}$

Qns 2. What is the first step in calculating the average revenue?

Ans. The first step in calculating the average revenue is the collection of data.

Qns 3. What does average revenue show?

Ans. Average revenue shows the revenue earned per unit of product sold.

raja
Updated on 13-Oct-2022 11:19:47

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