Revenue and profit are often used interchangeably, but they mean different things for your business. Here is an in-depth look into revenue vs. profit.
Revenue is what you make in sales. Profit is what you keep after you pay your expenses. If you invest in your business on a budget, knowing the differences between revenue vs. profits will keep your accounts in check by providing insight that helps you manage your income correctly.
Understanding the difference between the two will help you better manage your business finances and operations because it will identify whether you are operating at a loss regardless of revenue.
All money that your business brings in is considered revenue. This is the money you get from selling your products or services. It also includes income you generate from other investments like interest or rental income from your commercial properties.
Different businesses use different methods to record their revenue in their income statement. For instance, if you register revenue every time you make a sale even though you don't receive the money, you use accrual accounting to record your income. But if you record revenue after receiving your cash payment, your business uses cash-basis accounting.
The two primary types of revenue are operating revenue and non-operating revenue. Operating revenue is the revenue a business gets from its primary activities, which in most cases is business sales. The non-operating revenues are any money your business makes from other activities.
For example, the operating revenue of an apparel business would be the money it makes from selling apparel. If the company makes additional income from share dividends or other side investments, this is recorded as the non-operating revenue.
Between the two, operating revenue gives you a clearer insight into whether the company is growing in sales or not.
You can use sales, rent, dividend, interest, and contra revenue accounts to separate the different types of income your business accrues. The Contra revenue account is for your sales discounts and returns.
Remember that your revenue account increases by credit but decreases by debit. This means you should credit your revenues and debit your contra revenues, primarily if you use accrual accounting, to ensure your revenue remains balanced and provides some profits.
Revenue is calculated by multiplying the price of goods or services sold by the quantity of the goods or services you have sold.
Revenue = Quantity x Price of Product
For instance, if the apparel e-commerce website has sold 100 pieces of clothing in the last month, your revenue for that month is 100 x $20 = $2,000.
Profit is the money you make after deducting all your business expenses and taxes. The money is either reinvested or distributed among the business owners. Fun fact, most self-made millionaires become wealthy by reinvesting business profits instead of pocketing the money.
Additionally, knowing your business profits is crucial because it helps to determine your business performance. The different types of profit to include in your business income statement are gross profit, operating profit, and net profit.
This is the first level of profit you get from your business sales, making it the highest figure of profit you will get from your business. It is determined by deducting the cost of the goods sold (COGS) from your business sales.
One other thing to determine is the gross profit margin calculated by dividing the gross profit by the revenue of your business. If you get a high-profit margin ratio, it means your business is making a massive profit on every dollar spent.
On the other hand, a low-profit margin ratio indicates that the revenue per dollar your business is making is at a loss. Many investors or stakeholders in your company use the gross profit margin to determine the value of your business.
A big business might have better revenue and profit than a small business. Still, the small business gross profit margin might be higher, thus, indicating that the performance of the small business is better than that of the big company.
After your gross profit, determine your operating profit, which is the profit you get after deducting your cost of operations. It is determined by subtracting the operational costs from the gross profit. Gross profit provides insight into your business' monetary value after deducting the direct expenses of selling your products or services.
Operating profit helps you evaluate how your direct and indirect costs affect your profit. Direct costs are like machinery and labor costs, and indirect costs are like business utilities and office rent expenses.
This is the final amount of profit your business makes, as indicated in your income statement. It represents the profit you get after deducting all your business expenses, costs, interest, and taxes.
As such, it is the primary determinant of whether your business is healthy or not. Deduct your interest costs and tax from your operating profit to get your net income.
The difference between gross profit and net profit is that gross profit is the money your business earns after deducting the COGS. In contrast, net profit is the money your company makes after removing all the business expenses, including your taxes, interests, and other indirect costs.
With gross profit, you determine your business's capability to make a profit with respect to production. Whereas net income tells you how well your business operations are faring since it indicates a company's actual value. Here's an example:
Suppose it is a high sales season for your business. However, you fail to hire new employees to help with the spike in business operations and product demand in that season. In that case, you might find that your labor cost for that period increases due to employee overtime.
As a result, your gross profit margin and operating profit margin in that season might reduce since the operation costs will be high. However, you cannot use this value to determine your business's actual profits in the high season because you are yet to deduct the cost of taxes and interest. This is where net profit comes in.
Therefore, net profit is preferred for determining your business management's overall effectiveness and productivity. For instance, in the high season example, your gross profit might be increased due to the spike in demand.
But if you also took a loan to cater to the rise in demand, your interest expense will also increase. Therefore, the additional interest and labor cost might dent your net profit despite increasing demand and sales.
To determine your business profits deduct all your business expenses, taxes, and costs from your income revenue. Start by calculating your gross business profit.
For instance, if the COGS for the apparel company is $500 and the revenue made by the company in one month was $2000, then the gross profit will be $2000 - $500 = $1500. The gross profit margin, in this case, is $1500 divided by $2000 to get a 0.75 or 75% margin.
Suppose your direct and indirect operating costs amount to $500 – that is the sum of costs like administration, utility costs, labor costs, and the cost of machinery. As such, the operating profit is $1500 - $500 = $1000. In this case, the operating profit margin is $1000 divided by $ 2000, which gives 0.5 or 50%.
To calculate your net profit, deduct your taxes and interest from your operating profit. In our example above, if you pay monthly taxes that amount to $300 and your interest expense is $200, your net income will be $1000 – ($300 + $200) = $500. In this case, the net profit margin is $500 divided by $2000 to get 0.25 or 25%.
One sure way to tell the difference between revenue vs. profits is through your business expenses. On the surface, revenue is the income your business makes before you pay your costs, and profit is the income your business remains with after paying expenses.
It is possible to generate revenue and not make any profit, but you cannot make profits without making some form of revenue. Therefore, you will often find business revenue at the top of a business income statement while the profit is indicated on the last line of the income statement.
Additionally, gross profit is excellent at telling you how much sales your business makes, but it cannot fully identify your business profits. This is the function of your net income.
Both are significant, but profit is much more critical for businesses because it represents the money it actually makes. This means that additional branches of the business add to the revenue you make from your flagship business.
But what if the operational costs of a new branch are high, especially in the first few months of operation? In that case, the chances are that the net income from the new branch might be at zero or a negative value. Because of this early discrepancy while establishing your new branch, using the gross revenue to determine the profitability of your business could b blind-side you.
But if you use the net income from each branch, you will have an accurate depiction of your business performance. This gives profit a much better value than revenue.
Tracking both revenue and profit is essential for any business. However, it is crucial to understand that your business revenue does not reflect the cost of your expenses. Therefore, you must determine your revenue and net profit if you want to know your business's actual performance.
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Sources:
Income Statement Definition: Uses & Examples | Income Statement/Investopedia
What Is Accrual Accounting? | Business.org
Accrual Basis vs. Cash Basis Accounting | Accrual Basis vs Cash Basis Accounting/Score.org
Contra Account | Contra Account/Accounting corner
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