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So far the primary focus has been on Net Income and Cash Flow and what drives them. One issue that hasn't been addressed is the role Revenue plays in covering all the expenses incurred by a business. For example, for any given level of Net Income the Revenue must be adequate to cover the Cost of Goods Sold, Operating Expenses, Depreciation and Amortization, Net Interest, and Taxes. In this section, instead of starting with Revenue, the Income Statement will be worked backward, so to speak, and start with Net Income and end up with the Required Revenue to support the Net Income.

The analysis of Required Revenue begins by referring to Table 1-7 and then letting “RR” represent the Required Revenue to drive a level of Net Income.

Table 1-7 Income Statement for Calculating Required Revenue

By inspection:

[1-56]NI = Rev − COGS − OpExp − D & A ± NetInt − TaxesPaid

or

[1-57]NI = Rev − (COGSRatio)(Rev) − (OpExpRatio)(Rev)

− D & A ± NetInt − TaxesPaid

where:

COGS = (COGSRatio)(Rev) and OpExp = (OpExpRatio)(Rev)

If Rev is the Required Revenue (RR) to deliver Net Income NI, then

[1-58]NI = RR − (COGSRatio)(RR) − (OpExpRatio)(RR)

− D & A ± NetInt − TaxesPaid

Factoring,

[1-59]NI = (RR)(1 − COGSRatio − OpExpRatio) − D & A ± NetInt − TaxesPaid

Rearranging,

[1-60]RR(1 − COGS Ratio − OpExpRatio) = NI + D & A ± NetInt + TaxesPaid

Dividing both sides of [1-60] by (1 − COGSRatio − OpExpRatio),

[1-61]

Again by inspection of Table 1-7 it can be seen that

[1-62](1 − COGSRatio − OpExpRatio) = EBITDARatio

Substituting [1-62] in Equation [1-61], the revenue required (Required Revenue) to support a given level of Net Income is obtained:

[1-63]

or

[1-64]

Equation [1-64] tells an interesting story. It says that for a given level of financial performance the Revenue must be sufficient to cover the expected Net Income, Depreciation and Amortization, any Interest Expense, and Taxes Paid.25

Also, since

[1-8]TaxesPaid = (EBT)(TR)

then another form of Equation [1-64] is

[1-65]

Example 1-7: Calculating Required Revenue

Del Rey Corporation has a budgeted Net Income of $2,495,000 in Year 1 of its operating plan with an EBITDA of 11.5 %. If Depreciation and Amortization, Net Interest, and Taxes Paid are $1,735,000, $0, and $1,828,000 respectively, calculate the Required Revenue for each term in Equation [1-65] and the Total Required Revenue for Year 1 of the operating plan (Table 1-8).

Table 1-8 Condensed Income Statement for Del Rey Corporation

The Required Revenue to support the Net Income NI₁ of $2,495,000 is

Repeating this process, the Required Revenue for D&A, NetInt, and TaxPaid can be calculated.

Substituting in Equation [1-65] gives the Required Revenue in Year 1.

RR ₁ = 21,696,000 + 15,087,000 + 0 + 15,896,000

RR ₁ = $52,679,000

As can be seen from the example, approximately $15 million and $16 million of Revenue are required to cover Depreciation and Amortization and Taxes respectively, whereas roughly $21,700,000 of revenue is required to deliver the Year 1 Net Income in the operating plan.26