Speak to an investor or your board recently? Chances are they asked you questions about your revenue and profitability.
Your revenue and profitability give you important information about your company's financial health. Not understanding the difference between the two can lead to poor decision-making, mismanagement of resources, and a struggle to attract investors.
For example, you might be generating a lot of sales. But in reality, your profits are still low when you look closer at your financial reports.
By understanding these two terms, you'll make better decisions about cutting costs, optimizing your operations, and showing business growth to stakeholders.
Read on to learn the differences between revenue and profit to help you better understand your company’s financial health.
What Is Revenue?
Revenue is the amount of money a company makes from its operations. This usually includes the sale of goods or services. There are two different types to consider:
- One-Time Revenue – Just like it sounds, you only receive one-time revenue once. For example, if a customer pays for a 1x add-on service to their existing subscription
- Recurring Revenue – This type of revenue occurs on a repeated basis — typically monthly, quarterly, or yearly. You’ll generally produce recurring revenue by selling subscription products or ongoing services.
As a business owner, it’s important to keep track of both types of revenue. Doing so lets you compare the most recent periods to previous ones to determine your month-over-month, quarter-over-quarter, and year-over-year growth.
This typically correlates with higher margins, higher profits, and a growing company.
Gross And Net Sales
Revenue breaks down into gross and net sales:
- Gross Sales – Your gross sales are the total revenue you generate.. This is the top line of your income statement.
- Net Sales – Net sales are your gross sales minus the direct cost it for you to close them. For example, discounts, coupons, COGS, and other direct expenses.
Although gross and net sales are both revenue drivers, your net sales gives you a better understanding of the cash that actually makes it into your bank account.
Your goal as a business owner is to push your net sales as close to your gross sales as possible. If you do, you've minimized your cost of sales, resulting in more profit.
Operating Expenses And Deductions
It’s also important to pay close attention to your direct and operating costs, as these expenses affect your business's profitability. Here are the differences between the two:
- Direct Costs – These are costs you can attribute directly to producing or providing goods and services. For example, manufacturing labor hours, the cost of base materials, and the cost of manufacturing equipment all fall under direct costs.
- Operating Costs – Operating costs cover anything that’s not directly related to the production of goods and services. These include sales expenses like customer acquisition costs and general expenses like rent, utilities, marketing, office supplies, and more.
Once you have all your expenses and deductions in place, you’re ready to see how your company is doing in terms of profit.
What Is Profit?
Your total or net profit is the money you have left after factoring in your business expenses. You can find your net profit on the bottom line of your profit and loss statement (your P&L or income statement), but the profit formula is simple:
Total revenue - total expenses = total profit
As a business owner, this is the money you make after you pay your employees and all other costs associated with operating your company.
Profit margins are another great way to look at your profitability. You can find your profit margin by dividing your profits by your revenue and multiplying the result by 100 to display it as a percentage.
Here’s the profit margin formula:
Profit margin = (profit/revenue) X 100
For example, your company’s revenue last year was $850,000. After paying all your expenses and adjusting for deductions, your profit was$190,000.
Your profit margin formula would look like this:
(190,000/850,000) X 100 = 22.35%
Based on these figures, your profit accounts for 22.35% of your revenue, giving you a 22.35% profit margin. The higher your profit margin is, the larger percentage of your sales you can retain to grow your business.
However, there's no ideal set profit margin across the board. Some industries are known for higher profit margins than others.
Look at the profit margins of successful companies in your industry for a reasonable idea of what yours should be.
Gross Profit And Operating Profit
Investors and lenders want to see profit defined in two ways:
- Gross Profit – This is the amount of profit you generate after subtracting your cost of goods sold from your revenue. However, gross profit doesn’t account for all expenses. It’s important for investors to pay attention to this because it shows how profits are rising without the impact of operational costs. Higher gross profits also show investors and lenders that you use labor and supplies effectively.
- Operating Profit – Operating profit is the result of subtracting your operating expenses from your gross profit. Operating profits show how much profit a company is generating overall after accounting for all expenses. It's relevant to investors and lenders because it shows the bottom line of your company’s profit after accounting for all required costs.
Why The Distinction Between Revenue And Profit Matters
There are three key reasons why you should know the difference between your revenue and your profits.
1. Business Strategy
Understanding the relationship between your costs, revenue, and profitability gives you deeper insights into the performance of your business strategy.
As you break down the numbers and differentiate between revenue and profits, you’ll better understand your company’s cash flow and how to optimize it.
For example, if your profits are stagnant, but your revenues are growing, this may show that you need to consider cutting your manufacturing or marketing costs.
On the other hand, if revenue is stagnant but profits are growing, this might be an opportunity to invest funds from your increasing profit margin into marketing efforts to grow your business.
2. Annual Startup Taxes
Any entity that makes money must pay taxes — and that includes your business. However, you only pay annual taxes on your profits.
So, if you don’t track your expenses and differentiate between revenue and profits, you’ll miss out on potential write-offs and end up with a heavier tax burden.
When you’re on the hunt for new funding, investors will need to understand your revenues and profits before investing. Wise investors use both figures as a gauge of your company's value.
Revenue and profit also show investors how you manage your money and cover your company's obligations.
Revenue Vs Profit: What Are The Differences?
- Revenue is the total amount of money your company generates from the sale of goods or services.
- Profit is the amount of revenue left over after accounting for all of your expenses.
Revenue isn’t necessarily money in the bank, but it's still important to measure. When it’s growing steadily, it shows that you’re a stable company capable of attracting customers – a must-have for investor eyes!
Profits, on the other hand, are owned assets or money in the bank. Investors care about profits because they show how effectively your company is using resources to generate wealth. Profits are also a key indicator of your company's value and efficiency.
You can easily compare your profit and revenue by looking at your income statements, which include information about the money you're bringing in, what you're spending, and how much profit you're making.
Make Managing Your Business Finances Easier
Tracking your startup’s financial data and differentiating between revenue and profitability can be painful with old-school manual accounting practices. The good news is that accounting and bookkeeping have become easier through automated and AI-powered platforms.
Consider using software solutions to track your incoming cash, expenses, and profit in real-time.
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