Revenue and profit are two extremely important metrics in a company's P&L report (income statement). These two figures give you a picture of how much money a business can make.
However, there have been misunderstandings that revenue and profit are the same, as it is not uncommon to hear the words mentioned interchangeably.
In this article, we will dive into the difference between revenue and profit, why they are vital to business success and how revenue affects profit.
Before we dive deeper, we will first give you a brief overview of each term.
What is revenue
Business sales revenue/ revenue/sales is the total amount of money generated from selling goods or services. It is often referred to as the top line because it usually sits at the top of an income statement.
The income statement is one of the three financial statements (along with the balance sheet and cash flow statement) for reporting a company's financial health during a particular period.
An income statement tracks all the expenses and income and is primarily used to analyze a company's revenue, revenue growth, and operational costs.
It is worth noting that revenue only includes income from the primary operating activities of a business. For instance, a SaaS company earns interest yearly from its investment in stocks, and earnings from that cannot be calculated as revenue.
Sometimes people define revenue from all the sales without deducting any expenses as gross revenue (or so-called gross profit) after subtracting COGS (Cost of Goods Sold).
What is profit
A company's profit, sometimes called net profit, is the net income after accounting for all expenses, debts, additional income from non-operational activities and operating fees. Contrary to revenue, it sits at the end of the income statement and is often referred to as the bottom line of a company.
Though the formula for calculating profit is simple, just revenue minus expenses, there are other profit types between the top line revenue and bottom line (profit/ net profit), which can be utilized to analyze the performance of a company. Below are a few different type of profit and how to calculate them.
Gross profit is the net profit of a company after subtracting expenses related to making and selling products or providing services. It may also be referred to as gross income or sales profit.
Gross profit = Net sales - COGS
Net sales are the sum of a company's gross sales minus its returns, allowances and discounts. It is equal to revenue, or the amount of income generated from sales during the period. You can find net sales as the top line revenue of the income statement.
It's worth noting, however, that since companies don't provide much external transparency in the calculation, there is no universal formula for calculating net sales, but rather the components of the measure will vary depending on different companies or industries.
Net sales do not include the cost of goods sold, although the costs associated can be a significant factor in gross profit margin.
COGS represents the direct costs in the trading process and costs in the manufacturing, such as labor, all the materials, and direct overheads. It shows the performance of normal sales activities over a period in a company.
Gross profit and business finances
Gross profit reflects the efficiency of a business at using its labor, raw materials and other supplies. In other words, it examines how efficiently a company generates income from its existing materials and assets.
Operating profit is the net profit generated from a company's primary or core business. It excludes deduction of interests and taxes, as well as any profit earned from ancillary investments, such as business earned from other firms in which a company has a part interest.
Operating profit = revenue- COGS- operating expenses incurred during a given period- depreciation & amortization
The formula can also be simplified as gross profit minus operating costs and depreciation & amortization.
Income statements generally classify business expenses into six categories:
- Cost of goods sold (COGS)
- Selling, general and administrative expenses (SG&A)
- Depreciation and amortization
- Other operating expenses
- Interest expenses and income taxes
These costs can be considered operating costs, but interest expenses and income taxes are excluded when using the income statement to calculate operating income.Operating profit and business finances
Operating profit is a highly accurate indicator of a company's financial position. As it removes all irrelevant factors from the calculation and includes all expenses related to the company's operation.
For example, the calculation takes into account the depreciation and amortization of a company's assets.
Operating profit is also often referred to as operating income. However, if a company does not have any non-operating income, its operating profit is also equal to earnings before interest and tax (EBIT).
After deducting tax expenses, you can finally get the income statement's bottom line.
Most business owners would pay most attention to the very bottom line (profit). That's a wise choice, but you should also consider every line from top to bottom, as every detail of the company's revenue and profit matters.
Difference between revenue and profit
When referring to a company's profit, we usually don't mean gross profit or operating profit, but rather net income. Profit is the amount of a company's revenue that remains after all expenses (operating and non-operating) have been deducted.
Here are the main difference between revenue and profit.
Revenue is the income generated by a company through the sale of goods or the provision of services over a certain period, while profit remains after all business expenses and taxes deducted from revenue.
Thus, it is possible for a company to generate revenue and achieve a net loss at the same time.
By subtracting the total amount of allowance, discounts and returns from the total sales, you will get the sales revenue.
And if you deduct total expenses derived from business activities and taxes, you will get profit.
How does revenue affect profit
If revenues increase, will profits increase in tandem? The answer is that it depends.
The higher the revenue, the higher the potential it brings for your profit. But whether the possibility becomes a reality depends on the business strategy. For example, suppose your company is of relatively small size and plans to boost the business. In that case, you may want to invest every dollar into research and development or other activities that can push growth.
In this case, profit may not rise as much (or even decrease) even as the revenue of a company increases.
Net loss doesn't have to mean a revenue reduction, from this point of view. And growth in the revenue doesn't necessarily lead to profit increase, either. That's why it is essential to combine the two numbers together to evaluate the performance of a company.
Why revenue and profit are important
As mentioned above, the relationship between a company's profit and revenue varies based on the business goals.
If you own an early-stage company aiming for sustainable development, it is expected that you don't have profit for quite some time.
Your goal is to get your business off the ground and attract more customers and investors; therefore, you may lose money for months or even years. A well-known example is, Amazon the e-commerce giant didn't generate profit until 2004, but Jeff Bezos had been in business since 1996.
However, for a company that seeks high profitability, e.g., indie founders and startups, as the business is their primary source of income, they may expect earlier profit growth along with business revenue increase.