Revenue vs. profit: What it means for your business health
Revenue and profit are the cornerstones of a successful business. Your success boils down to if you’re generating revenue and turning a healthy profit. By starting with revenue and profit, then working your way down, you can accurately assess your business’s well-being. This is why you have to understand the differences between revenue and profit.
- Revenue is the total income generated from normal business operations, including the sale of goods or services.
- Profit is the income that remains after subtracting all expenses, debts, taxes, and operating costs.
- There are three types of profit, gross profit, operating profit, and net profit. When referring to a business’s profit, you usually refer to net profit.
What is revenue?
Revenue is the total income generated from normal business operations, including the sale of goods or services. Revenue is usually generated from sales. However, it may come via fees, interest, donations, grants, capital gains, and investments.
Revenue is often referred to as the top line because it is literally the first line on a company income statement.
Types of revenue
- Gross Revenue: The sum of all income generated by the business.
- Net Revenue: Gross revenue minus directly related selling expenses (COGS).
- Operating Revenue: All income generated from normal business operations.
- Non-Operating Revenue: All income generated from secondary income sources.
Revenue vs. sales
Revenue is commonly referred to as sales, but there is a difference. Sales is income generated from selling goods or services, while revenue includes all forms of income.
What is profit?
Profit is the income that remains after subtracting all expenses, debts, taxes, and operating costs. Profit is often called net profit or the bottom line since it’s at the bottom of the income statement.
Types of profit
- Gross Profit: Revenue minus the cost of goods sold (COGS).
- Operating Profit: Gross profit minus all other fixed and variable expenses like rent, payroll, and utilities.
- Net Profit: What’s left over after all expenses are deducted, including taxes, interest, and miscellaneous one-time items.
Practical example: Lisa, the shoe manufacturer
Let’s create a fictional scenario to walk through how to calculate net profit from gross revenue.
Lisa owns a company that sells shoes. In 2022, her company sold 5,000 pairs of shoes for an average price of $100. This means that she generated a grand total of $500,000 in gross revenue.
Unfortunately, Lisa doesn’t get to keep all of that money. To craft her shoes, she has COGS, which amount to $30 per shoe. These expenses sum all costs related to creating her product, including equipment and labor. Subtracting her COGS gives us a net revenue of $350,000.
$350,000 is not the final number because Lisa has other expenses like rent, insurance, and taxes.
Lisa’s rent is $2,000/month, and her insurance is $1,500/month. She paid $25,000 in miscellaneous expenses throughout the year, and her business paid $125,000 in taxes in 2022. These are her operating expenses, which amount to $192,000.
Lastly, we’re led to our final number, net profit.
In 2022, Lisa’s shoe company made a net profit of $158,000.
What’s more important: revenue or profit?
The simple answer to this question is profit. As the saying goes, “It’s not about how much you make; it’s about how much you keep.” You want to see the biggest number possible in the net profit column. You also want to keep your operating expenses low, increasing your profit margins.
What can you learn from your revenue and profit numbers?
There isn’t a time when a business would want to have a low-profit margin. Knowing your numbers allows you to diagnose and determine where you’re “leaking” money. This is the natural lifecycle of every business. It’s virtually impossible to see how big your business can grow without first spending money in areas you later find invaluable.
What if you’re not interested in growing a huge business?
Then consider using the “Profit-First” method, which involves allocating a specific percentage of each sale to profit before expenses are paid. This can force you to minimize expenses, so you don’t overspend. Running a business is like raising a child; we want to invest as much money as possible, sometimes even to its detriment.
When your business makes “too much” money
Excuse me? Too much money? Yes, there is such a thing as making too much profit when growing a business. A mistake many businesses have made is prioritizing profits till the bitter end.
Few business ideas last forever, and the ones that do still need to innovate to stave off competition. No, we’re not demonizing profitability but rather the idea of losing focus on moving the needle forward. An easy example is Blockbuster, who had an opportunity to purchase Netflix in 2000 for $50 million. They passed, and ten years later, filed for bankruptcy.
Exceptions to the rule
However, as with all things in business, the truth lies in the gray area. Many businesses operate on thin margins as they grow. These are called capital-intensive businesses, with examples being eCommerce stores and airlines. Other businesses, like SaaS companies and online businesses, may focus on profit. They know that the cost of one customer is relatively low.
Other than the type of business, you should also factor in the business stage.
A business needs to focus on getting customers and building a solid product in its early stages. This may be at the expense of spending more on acquisition, R&D, and recruitment. Eventually, the goal is to lower your operating expenses by cutting unnecessary expenses.
This brings us full circle to the beginning of the article. You can make sound financial decisions by knowing your numbers, like revenue and profit.
Don’t handle business finances alone
To know your numbers and make sound financial decisions, you need to invest time. The problem is that your business likely has dozens of monthly or daily expenses. Luckily, some tools can help you organize your finances and finalize your numbers faster. The learning curve to building a profitable business is steep. You need to develop systems and processes over time.
One tool that can help you systematize your business is ComplYant. Taxes are one of the biggest expenses businesses face. Not only are they costly, but they steal precious time away from you doing what you love. ComplYant can help you save time and money with our tax assistant tools.