Are you looking to increase your business efficiency? As a small business owner, it’s important to understand what’s the difference between revenue and profit.
Revenue is the total amount of money that your company brings in from sales or services rendered. Profit, on the other hand, is what’s left over after all expenses are paid.
Understanding what’s the difference between revenue and profit can help you make better decisions for your company. If you are trying to increase profits, you may need to focus on cutting back expenses rather than increasing sales. Meanwhile, if you want to boost revenue, generating more sales would be a better strategy.
No matter what your goal is, knowing how revenue and profit work can help you achieve it more efficiently!
What’s the Difference Between Revenue and Profit?
Although revenue and profits sound similar, they are very different. While revenue is the total amount of money that a business takes in, its net profit is the amount left over after paying all of its bills.
You can have high revenues and still lose money if your expenses are higher than your earnings.
The income statement is a key financial document that details a company’s revenue and expenses. By closely examining this document, you can get insights into where a company is spending too much and identify areas where cost-cutting measures could lead to increased profits.
What is Revenue?
Revenue refers to the total amount that a business receives from its normal operations. This amount includes any returns or discounts.
This number is known as the top line because it’s the first line on the statement and all expenses are subtracted from it.
As a company, the primary goal of business is to make money. A clothing store does this by buying and selling fabrics and clothing. The core business activity is to sell clothes.
The primary purpose of a fabric shop is to sell fabrics and supplies to customers who want to make clothing, curtains, or other home goods. This accounts for at least half of the stores’ revenue.
If the small business has 5% of their income coming from investments, these are not part of their main line of business.
The clothing retailer is not an investment company; less than half of its revenue comes from these activities.
Keeping your operation and non-operation finances separate is important for accounting purposes and tax filing.
The inclusion of this number into the total revenue generated by your primary business activities can be troublesome if it’s ever called into question during an audit or if reconciliation is required.
Types of Revenue
There are two methods of revenue calculation: cash and accrual.
Under accrual accounting, a sale is recorded on the company’s books even if the customer hasn’t paid yet. For example, if a company sells something on credit to a client, the sale is recorded in the income statement even though the company doesn’t get paid until later.
With cash-basis accounting, sales are only recorded as income when the invoice has been paid. If a customer hasn’t paid their bill, but they’ve received their product or service, it’s considered a pending transaction.
Revenue can also be classified as operating revenue and non-operating revenue.
Operating revenue is income from the company’s primary business activities or known as recurrent revenue.
Non-operating revenues, such as investment gains or the sale of assets, are one-off sources of income that are added to the top line of a company’s income statement. However, these sources of non-recurring cash are not considered primary business activities.
The formula for calculating revenue is: sales revenue = sales price x number of units sold
What is Profit?
Profit, also known as the bottom line because of its position on the income statement, is what is left over after all business-related costs are deducted. These costs include rent or mortgage, utilities, payroll, and taxes.
The last line on the spreadsheet is the net profit.
Companies can use the net profit to pay out dividends to their shareholders or reinvest the money back into the business.
The bottom-line number shows how much profit the business has generated over a given period. This number is arrived at by subtracting all business expenses from the total revenue.
The total revenue is at the top, followed by operating costs, which are subtracted to reach the bottom line, which is your net profit.
Types of Profit
There are three types of profit: gross, operating, and net.
The gross profit is the total amount of money a business makes after subtracting the cost of production or the cost of services.
The company’s operating profit is the money it made from its main business activities, before paying any tax, interest, or dividends.
The net profit is the final figure after all expenses have been deducted from the total revenue.
Each type of profit reduces the overall profit amount by deducting different categories of expenses in clusters.
Which is a More Important Number: Revenue or Profit?
While both numbers are important, net profit is a more accurate reflection of a company’s financial health. It factors in all of the business’ expenses and shows how well the company is handling its money.
Knowing your gross profit margin is important, as it can tell you a lot about your company’s sales, production, and operating costs. Looking at your top line or growth in gross sales can give you insight into how strong your business is and its growth potential.
Gross profit is not the most accurate way to measure the overall profitability of a business because it ignores all expenses related to production, such as rent, utilities, and employee salaries.
Net profit, or bottom line, is the number that shows how profitable your business is.
How Revenue Affects Profit
The more profit you make, the more you can reinvest in your business.
For example, a company making $100,000 in revenue can only have a maximum net profit of $100,000. This is assuming you have no overhead costs.
A business’ profitability is not only dependent on its sales but its costs as well. A company that earns $500,000 in revenues could make more money if its costs are lower compared to a company that generates the same amount of money.
When you’re making $500,000 in annual revenue, you have more money to put into growing your business. This is in comparison to a company with only $50,000 in annual earnings, which doesn’t have as much money to re-invest into the company.
Why Revenue and Profit Are Both Important
The correlation between revenue and profit is of extreme importance.
Many startup companies, especially ones with seed money, operate on the idea that they won’t be able to turn a profit for a while.
Because they’re a new company, their main goal is to generate some revenue and prove to people that there’s a demand for their product or service.
Because of this, many startups might struggle for years, even operating at a deficit.
If the goal of your business is to sell it to another firm, then generating a profit may not be your top priority. As long as you have cash in the bank, you can continue operations even if your company isn’t profitable.
Some businesses, such as independent companies or startups that are self-funded, may want to generate high profits as quickly as possible. This can help them have a more stable revenue stream and lessen their chances of going out of business due to a lack of funding.
Reporting revenue and profits are important when showing your investors or company how much you’ve grown.
Let’s compare two companies:
- Company A generates $500K in monthly revenue with $700K in monthly expenses
- Company B generates $150K in monthly revenue with $50K in expenses
At first glance, it would seem that company A is doing better than B. But if you look at their profitability, you’ll see that it’s actually the other way around. Even though A makes more sales, it’s less profitable than B. This is why it’s critical to look at both sales and profits when analyzing a business.
Just because one company makes more money doesn’t mean they’re “better” than another company.
If company A can reduce its costs, it could possibly make more money than company B.
Companies with healthier margins tend to fetch higher selling prices, making them more desirable to buyers.
A net loss can be an indicator of a company’s inability to turn a profit.
What to Do When You’re Generating Revenue But Not Profit
If things aren’t going well at your company, here are a couple of options to consider.
Increase Your Margins
Look at your gross profit. If you can lower your production costs you can make each sale more profitable.
For example, if you sell your widgets for $50 and your current COGS is $40, you have a gross profit of $10 per widget you sell.
If you lower your COGS by $10 and sell 1,000 widgets per month, you would instantly double your gross profit.
If you are unable to lower your COGS, then increasing your price may be the next best option.
By raising the price of your widgets from $50 to $60, while keeping the same $40 COGS, you will see an increase in your gross profit per widget. This could potentially lead to a higher total gross profit if you sell 1,000 widgets.
Both methods have the same effect on your gross profit margin. This is an easy way to improve your profits by tweaking your margins.
Another way to improve your profits is to optimize your operations. Your operating profit is the money left over after you subtract your operating costs such as rent, payroll, and marketing.
Here are a few examples of ways you can lower your overhead costs.
- Payroll: How to reduce payroll expenses for a startup depends on many factors. Cutting salaries or laying off employees should be the last resort, and should only be done if absolutely necessary. Other options include a hiring freeze, or cutting back on certain employee benefits.
- Marketing: Look into ways to lower the cost of acquiring customers from specific channels and cut any underperforming channels.
- Office expenses: Since COVID-19, more companies have switched to working remotely which has saved them money on things like office space and cafeteria lunches.
If you want to reduce your operational expenses, one of the best ways to start is by creating a budget.
If you’re looking to increase your business efficiency, it’s important to understand what’s the difference between revenue and profit. Revenue is the total amount of money that your company brings in from sales or services rendered. Profit is what’s left over after all expenses are paid. Knowing this distinction can help you make better decisions for your company moving forward.