Ah yes, revenue and profit. When I was starting out, I also frequently swapped the words.
I thought they meant similar, the same numbers you look at when deciding if your business is doing well. You could interchange them in your statement, and the thought would basically mean the same.
After learning a little bit about the business and accounting side of things, I learned that the two terms have quite a lot of differences. You can’t use them interchangeably as I initially thought.
When examining your business’ finances, it is crucial to understand the meaning and differences between ‘revenue’ and profit.’ Differentiating between the two allows you to structure better plans to improve the figure that needs improving.
While laymen use these terms almost interchangeably, they are two related concepts but have different meanings. Using these terms for the wrong goals and purposes may lead to inconsistencies, or even mistakes, in the budgeting and accounting function.
I looked back at my business pitches in the past and my use of these two terms. I guess I used them wrong back then.
Well, you live and learn. Now I don’t make the same mistake. And neither should you, once you know the difference between them.
Read on and know more about revenue, profit, and the differences between the two.
What Is revenue?
Revenue is the amount received by a firm from business activities. Revenue is generally computed by multiplying the number of units sold by the unit price, either for credit or cash.
In the case of service firms, revenue is the amount received for the services, also either for credit or cash.
If you are a merchandising firm or a service entity, then retail sales of your products or the payment of your services, respectively, are the revenues.
For a more straightforward definition, revenues are simply all the money generated before deducting any expenses. Revenue is also referred to as the “top line” because the figure is the first line item in an income statement.
The term “sales revenue” is often used interchangeably with “revenue.” The figure shows the total amount the business generates from the sale of goods or merchandise.
Even if the two are interchangeable, though, not all revenue is derived from the sale of goods or services. There are also other sources of revenue like interest and dividends earned, and they may be added to sales revenue as a separate line item to find the total revenue.
This number can be broken down further to know two things. One is the total receipts from the sales of services or goods (gross sales revenue); another is the resulting amount taking into consideration deductions from gross sales revenue relating to discounts and returns (net sales revenue).
These are the two classifications of sales revenues.
- Gross sales revenue pertains to all the product sales and billings from the sale of merchandise or services, either for cash or credit. The gross amount does not take into computation sales discounts or product returns.
- Net sales revenue is the gross amount less discounts, returns, and allowances.
To illustrate the difference between the two, take this single-transaction example.
Your company sells a product for $3,000 and offers a 10% sales discount when the customer pays upfront. Let’s say a customer does just that: the gross sales revenue amount for that transaction is $3,000, and the net sales amount is $2,700 [$3,000 – $300 sales discount ($3,000 x 10%)].
That is not to say that gross revenue is not a useful metric. This amount still provides valuable insight, particularly on the capability of your business or goods to sell and the capacity that it will turn a profit.
However, when you purchase an existing business, you don’t focus on the gross revenue amounts. If the company offers a lot of discounts or allowances, then the gross and net revenue amounts could be far off each other.
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Accrued and unearned revenue
Accounting has special revenue concepts, namely accrued and unearned revenue. Accrued revenue is revenue earned while not yet paid by a customer.
For example, a company sells $1,000 worth of goods on net-15 terms. This means that the buyer does not have to pay until 15 days after the purchase, and the selling company will invoice only upon that time.
The revenue for this transaction is considered as accrued revenue. From an accounting stance, this is considered as a part of the top-line revenue of the income statement.
Unearned revenue is the amount a buyer prepays for services or goods that have not been delivered. If a company requires prepayment for purchase, then they would not record that revenue first in the income statement; they are unearned.
Once the goods or services relating to the prepayment have been delivered, the company transfers the revenue from unearned to earned. This means that they now recognize it in the top-line revenue of the financial position statement.
What is profit?
Profit refers to the total revenues less the expenses incurred by the company. Whereas revenue is often referred to as the “top line,” income is often called the “bottom line” because it is found at the bottom of the income statement.
While revenue only considers the amount received from operations, profit considers both the inflows (revenue) and outflows (expenses) of cash and resources
Types of profit
There are three kinds of profit illustrated in a formal statement of financial performance or income statement.
- Gross profit is the amount of sales less cost of goods sold. To illustrate the concept of cost of goods sold, here is an example.
Suppose you, as a retailer company, purchases merchandise worth $10,000, to sell at a 20% markup, or $12,000 ($10,000 x 120%).
If you sell all of those goods, you receive revenue of $12,000. The cost of the purchased merchandise (goods sold) is $10,000, so your gross profit from the transactions is $2,000 ($12,000-$10,000).
Another term for gross profit is gross margin.
- Operating profit refers to gross profit less operating expenses. In an income statement, sometimes there is a line item named “income from continuing operations,” which is basically the same as operating profit.
To illustrate, imagine you have a gross profit of $100,000. Expenses relating to advertising, production, and other costs associated with the operations of the business amounted to $50,000.
The total operating profit is $50,000 after deducting those expenses from gross profit.
- Net profit is the remaining income after all expenses have been paid. Continuing the operating profit example, suppose other expenses (finance expenses, administrative expenses such as utilities and rent) amounted to $25,000.
The net profit of the company will amount to $25,000.
Operating profit is not often reflected in an income statement, but gross and net profit are always included. That is why gross and net are the two kinds of profits most frequently mentioned.
Gain on sale
There is a particular type of earning referred to as a gain. To understand this, let me outline the concept of fixed assets and depreciation.
Fixed assets are those investments by a company in physical properties used in operations and last for more than one year. Examples of these are computer equipment, office furniture, or a new office building.
Over time, the value of fixed assets deteriorate, and the rate depends on the method applied by a company. The most common, though, is the straight-line method, where the amount of the yearly decline in value is constant.
This process is called depreciation and acts as the distribution of the expense (purchase price of the property, plant, or equipment) over the useful life of the asset (as appraised by an independent appraiser).
For example, suppose you buy a 3D printer for use in operations worth $2,000, with a ten-year useful life. The annual depreciation is $200, or $2,000/10 years.
The book value or carrying amount is the purchase price less the total depreciation accumulated over the years. In two years, total depreciation would be $400, and book value would be $1,600 ($2,000 – $400).
In four years, the total depreciation is $800, and the book value would be $1,200. Book value of a fixed asset changes depending on the total accumulated depreciation related to that particular asset.
Now when a company sells a fixed asset at an amount higher than its present book value, a gain occurs. Since selling the business properties is not a typical business routine, gain on sale is not recognized as operating income.
There is also a loss on sale, when the selling price is lower than the book value.
Gains and losses on sale of assets can go below the operating profit section of the income statement. They might be shown on their separate line item, or are lumped together with other items in an all-inclusive category such as “Non-Operating Income” or “Other Income.”
Other types of non-operating income are rent payments from your building tenants (unless your main business is renting out space for tenants), interest income from bank deposits or loans, and dividends received from other companies.
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The difference between the two
Just from the discussion of the two above, it is clear that revenue and profit are not so similar as you once thought. Here are the main differences between the two commonly interchanged terms.
Revenue is the proceeds from the business activities, either cash or credit, without taking into consideration the expenses incurred. If you sold equipment at $2,000 with a 10% trade discount for a total cash receipt of $1,800, your gross revenue is $2,000, while the net revenue is $1,800.
Revenue is sometimes referred to as ‘sales.’
Income, on the other hand, is what is left of the revenue after deducting all expenses. Continuing the example above, if total costs are $1,000, then going from net revenue of $1,800, the net income is $800.
To compute gross revenue, you multiply per unit price with the total quantity of units sold. For net revenue, subtract from the gross revenue the total discounts and returns granted.
To compute gross profit, you will subtract the cost of goods sold from the net revenue. Gross profit less all expenses, selling, administrative, and otherwise, equals the net profit or the bottom line figure and is ultimately the result of business operations.
Subset and superset
Revenue is a superset of profit. Revenue encompasses profit, for without it, there is no positive bottom line.
On the other hand, profit is a subset of revenue. Positive profit numbers depend on the existence of revenue, and without it, there is no profit.
Take note, however, that this is positive revenue. If you have $0 revenue but $5,000 in expense, then you have a $5,000 negative profit, or loss.
However, a company, of course, focuses on making a profit and not losses, so they are not included in the revenue subset.
Revenue is still earned without profit. This is even though there can be a loss when the expenses exceed the revenues.
Now the same cannot be said about profit. Without revenue, there is no profit.
The fact is that no matter what, you will always incur expenses in a business. If there is no revenue, then there would be nothing to cushion your costs.
In terms of kinds of revenue based on the income statement line item classifications, there is gross sales revenue and net sales revenue.
In terms of its types based on source, revenue can be classified into operating and non-operating. Operating revenue means receipts and billings from your primary business activity (selling, manufacturing, retailing, service, etc.).
- Selling of products for a retail business
- Sale of homes of a real estate venture
- Extermination services of an extermination crew
- Cleaning services of a housekeeping firm
- Interest revenue by a lending institution
Non-operating revenue refers to those earnings not related to the primary conduct of business. Examples of non-operating revenue are:
- Receipt of dividends
- Interest revenue from bank deposits and loans
- Gain on investments
- Gain on foreign exchange
- Gain on sale of assets
Income has two types – gross and net. Both are reflected in the income statement.
Position on income statement
Revenue, being the “top line,” sits on the very top of an income statement. It is the very first line item in the financial statement.
Income is the “bottom line,” and as expected, sits at the bottom of the income statement. The income is the ultimate result of operations and can be considered as one of the most important metrics for business performance and success.
Importance of revenue and profit
Revenue is vital in running a business. It covers the total expenses, and the leftover after paying for the costs is the income.
Without sufficient levels of revenue, business operations will be hampered.
Now, income is more of a driver for business growth and survival. You do business not to break even (revenues equals expenses) and earn negative or zero income; you do business to make a profit.
When you always break even only, your company won’t grow. You are not deriving value from the contributions of your shareholders, you are not gaining wealth, and chances are your company won’t survive.
When your business turns profits, then your company has a chance to grow, provided you make the correct decisions. You also won’t turn bankrupt and run the contributions of investors and shareholders to the ground.
Sales revenue is dependent on the quantity sold at a particular price point, so this is a useful metric of the desirability and demand of the product. Profit reveals the value a business derives from its operations.
Continuous improvements to manufacturing methods and cost reductions in the selling and administrative side of the firm drive profit levels up by lowering costs. Aggressive marketing efforts, or higher pricing, are efforts to bring profits up by also raising revenues.
Proper cost-volume-profit analysis must be done so that you can see just how much you can raise prices or costs to get the most revenues without costing too many expenses.
Profits and revenues are essential metrics for an investor because they are windows to a company’s overall economic health. For management, the amounts are useful for a lot of things, such as fixing the pricing of your services and products, crafting your annual budget, and more.
Both revenue and profit are looked at to know if a business is profitable or not.
Business goals for revenue and profit
Now that you know the difference between revenue and profit, and their importance to a business, you must take action to further raise both of these. Here are the things you may want to do to balance the levels of these two.
- As a rule, increasing revenues should not only focus on getting more sales, but also the price to increase the revenue. When you make strategies to increase sales, there usually are also increases in costs, such as advertising or marketing. If the resulting income levels are not satisfactory for the company, then you must increase prices. The price increase in the product should cover the additional expenses. However, increasing the price too much may result in a decline in sales, and therefore, a drop in profit. There is a fine line to tread, so be careful.
- The higher the revenues, the higher the profits can be. The rate of the increase in income, however, is not always the same as the rate of revenue increase.
- Enhancing the profit margin is a different job altogether. However, it follows the same principle as having a fine line to walk on. When the overall profits rise faster than the associated expenses, then an increase in profit margins will result. This is achieved by doing steps to raise profit at the lowest possible costs. It can be hard to balance but will lead to higher profitability for an extended length of time.
Now that you have a thorough understanding of everything surrounding revenue and profit, you will not confuse one for the other anymore. Here are the key takeaways to remember.
- Revenue is the total income by a business from the sale of services and products. Profit is the leftover revenue when all the expenses have been accounted for.
- Revenues and profits are connected, but just because there is revenue does not mean that profit will surely accrue.
- Revenues will almost always exist since that is the reason for establishing a business. However, if the expenses are more than the revenues, then there is a loss; profits will not appear in this case.
- Investors and shareholders are interested and will look at the standalone revenue and profit numbers. However, the part of revenue converted to profit is something that they will examine extensively.
- Revenue cannot be controlled since many factors affect it both externally and internally. On the other hand, net income can generally be controlled and managed accordingly because costs and expenses are mostly an internal factor. In economic downturns, where sales are not rising or even declining, you will not control the revenue levels. But you can control the expenses, so these are managed first to adjust your overall profit margins.
- Looking at sales revenue gleans insights on the demand of your products or services, while profits tell you the value a company keeps for themselves at a given price point.
From the discussion above, you can see that while revenue and profits are closely linked, they are ultimately unique concepts that behave differently. To add another layer of complexity, both have synonymous terms which can sound foreign to those without a business background.
The critical point, however, is that you now know the differences between the two. Now you won’t mindlessly interchange them, thinking that you are saying the same thing.
However, knowing what the terms mean is only half the battle. Taking a look at your company’s or business’ financials and taking proper actions are the next step in bringing it to greater heights.
Revenues and profits are two essential indicators of overall financial health and longevity for the future. Profit stems from revenue, so if you want to grow your business, then make efforts to raise revenue, or at least lower the expenses.
Both are equally essential for the present and future of the company, and neglecting one may affect the other, and the finances of your company as a whole.
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