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If you run a business, you need to understand how revenue vs profit works. Knowing the difference between the two is a vital part of understanding the cash flow of your business and ascertaining how successful that business is. Revenue vs profit will also help to explain whether your overheads are too high, your sales figures too low and if the prices you’re charging for goods and services are correct.
Revenue vs profit and the difference between the two
Revenue is sometimes known as ‘the top line’ because it is detailed at the top of any income statement your business produces. In simple terms, the revenue of your business is the amount of income it generates before expenses have been deducted. If your business sells handbags, for example, the money you make from selling the bags is the revenue of your business. If you also generate income from sources such as investments or satellite companies, this isn’t counted as revenue, as additional income streams are handled in a separate part of any accounts.
Another term for profit when considering revenue vs profit is ‘net income’ – also known as the bottom line. To make matters slightly more complicated there are various forms of profit to consider before arriving at the overall figure known as net profit. These include gross profit and operating profit.
The gross profit is calculated by taking the revenue and subtracting the cost of goods sold (COGS). This figure is the amount which directly funds the production of the goods being sold, such as the materials used to make the goods and the cost of any labour you employ.
The operating profit is calculated by taking the gross profit and subtracting what are known as fixed and variable expenses. These could include any rent you have to pay, utility bills and loan repayments.
The key differences between revenue vs profit
If someone refers to the profit their company generates, they are talking about net income rather than gross profit or operating profit. This is the final amount left once all expenses have been deducted from revenue. It is perfectly possible for a business to generate revenue – even a healthy amount – and yet still operate at a loss rather than a profit. This happens if the money paid out by the business on the expenses outlined above is higher than the revenue coming in.
Operating at a loss in this way may be acceptable during certain phases in the operating cycle of a business, such as when it is being established or during a period of investment in assets such as plant and stock.
If loss-making continues over the longer term, it indicates that the revenue vs profit calculation needs to be rethought. Either the sales generated are too low, the price charged per item isn’t high enough, or the overheads attached to the business are too steep for it to survive.
An analysis of revenue vs profit – including gross profit and operating profit – should enable you to spot which part of the equation needs to be tweaked. However, it’s often the case that sales figures, overheads and the price point all need adjusting in order to reverse a loss-making situation.
Profit vs revenue – which matters more?
Although figures for revenue and profit are both important in their own right, net profit figure offers a fuller picture of the financial well-being of a company, since it creates a snapshot which allows for expenses and liabilities.