If you make $1 million a year in revenue, but can only pay yourself a profit of $20,000, is your business successful? đ€ The answer might actually be subjective â it depends on your goals and the stage your business is in. Yes, business success is traditionally measured by its ability to maximize profit â but that doesnât mean we should overlook revenue as a metric. So letâs take a closer look at the difference between revenue vs profit and exactly what these metrics tell you about your business. đ
The main difference between revenue and profit is that revenue refers to how much money a business makes while profit refers to how much a business keeps after deducting expenses.
Another way to understand the difference is to look at the equation for calculating profit:
Total Revenue - Total Expenses = Profit
Revenue is the total amount of income generated by your business from the sales of goods or services before any expenses. đ° If you add up the total sales generated by your company, that is your companyâs total revenue for the year. đ
Revenue is often referred to as âtop-lineâ because it sits at the top of the income statement and represents the money flowing into your company. đ Depending on the type of goods or services your company sells, your income statement may look different compared to other companies. Youâll sometimes see revenue split up into product revenue or service revenue, such as in the Microsoft example below. đ
This screenshot shows Microsoftâs 2021 Q4 income statement. Total revenue is reported on the top line.
Ever heard the saying that ârevenue is vanity, profit is sanityâ?đ While itâs true that profit is a critical metric, donât be too quick to dismiss revenue! Revenue reflects the demand for your products and services and is an indicator of year-over-year business growth. So, we canât downplay its importance. With that covered, letâs turn to the other important metric: profit.
Profit = Revenue - Expenses
Profit or ânet incomeâ is the total amount of money a business keeps after deducting expenses. In financial jargon, profit is often referred to as the âbottom lineâ as itâs quite literally the last line found on an income statement.
This screenshot shows Aritziaâs 2021 Q4 income statement. Net profit is reported on the bottom line.
For most small businesses, profit is the more important metric to understand as it represents how much money the business gets to keep, after deducting the following:
Costs associated with the production of goods such as labor and raw materials
Operating costs such as rent for office, utilities, marketing and research and development
Taxes
Interest
Depreciation
Amortization
According to economist Milton Friedman đ€ â the entire purpose of most businesses, at least traditionally speaking, is to generate profits. The higher the profit, the more money your business earns.
Profit can be depicted as either a positive đ or negative number đ. When net profit is a negative number, itâs referred to as a loss because the company did not make enough money to cover its expenses.
Just as you might see different revenue types on your income statement, there's also more than one type of profit. Here's how to make sense of the most common types:
Gross profit is defined as revenue minus the cost of goods sold. For example, the cost of materials and labor directly associated with producing a product. Gross profit doesnât include other fixed costs such as rent and the salary of individuals not involved in producing a product.
Operating profit is gross profit minus operating expenses such as rent, payroll and utilities. Operating profit represents the total earnings before interest and taxes.
You get net profit by deducing all your expenses from your revenue. This includes everything from the cost of goods sold and payroll to taxes and interest payments. Itâs what your company keeps after every single expense has been paid off.
For small businesses, profit is the more important metric to understand as it represents how much money you get to take home at the end of the day, after deducting the costs of goods sold, operating expenses, taxes and interest. However, business owners probably shouldnât care about profit as much as they should about profitability. đ
Whatâs profitability and how does it differ from profit? Profitability or profit margin is the measure of your companyâs ability to generate profit relative to revenue. It is usually measured using ratios like gross profit margin and net profit margin.
Most business owners understand the basics of profitability â if revenue from sales covers your expenses, youâre turning a profit. If your revenue is $1 million and your expenses are $500,000, then you make a profit of $500,000 or a profit margin of 50%.
Profit alone can be misleading â it doesnât show the full financial picture. Letâs illustrate this with an example using two companies.
Company A has:
A revenue of $4,000,000
Expenses worth $3,600,000
Hence, a profit of $400,000
Company B has:
A revenue of $2,000,000
Expenses worth $1,600,000,
Therefore, they also make a profit of $400,000
Both companies make the same profit but what about their profitability â are they equally profitable?
The answer is no, because Company A has to spend far more money to generate the same amount of profit as Company B. This makes Company A a lot more sensitive to any increases in cost.
Let's explain this by using a hypothetical scenario where a cost, like fuel, has increased.
Companies A and B respectively spent $800,000 and $400,000 on fuel last year
Gas prices rise 10% this year
If all other factors remain the same, Company Aâs:
costs would rise by $80,000
profit would drop to $320,000
profit margin is 10%
Company Bâs:
costs would rise by $40,000
profit would decrease to $360,000
profit margin is 20%
Company B is more resilient to cost changes đȘđ» when compared to Company A because of its higher profit margin. Even though prices increased by the same percentage for both companies, because Company B spends less on this expense, they are more profitable in this situation.
If youâre a business owner, you care about your bottom line. Here are some tried and true tips on how to increase profitability for your company.
A well-planned business budget can help you forecast earnings and expenses, achieve financial goals and keep your business profitable.
Learn more about other business budgeting methods.
Increasing revenue doesn't necessarily result in increased profitability. Operating costs, marketing costs and the cost of raw materials can add up. Find efficiencies in your operations and learn to work smarter, not harder.
For example, if you spend a lot of time managing accounts payable the traditional way, consider automating these processes to save time, money and resources.
Organizing all your expenses into multiple accounts can help you get a clearer picture of how much your business spends, how much youâre paying taxes and how much youâre earning.
For example, you can set up different checking accounts for each of the following:
Payroll đ°
Utilities đ
Marketing expenses đ©đ»âđ»
Taxes đČ
And anything else your business needs to track đĄ
If youâre looking for a business banking accounting designed to help you gain clearer insight into your businessâ profitability, then Relay might be a perfect solution. Itâs a money management platform that helps you take control of your cash with up to 20 free checking accounts per business. Get started with a free account by applying online in 10 minutes. đ
Operating profit tells you how efficiently youâre running your business. How much money do you have left over after all the necessary expenses of running your business are deducted? The operating profit formula helps you figure out this number.
What is accounts payable (AP) automation? âïž Understand the four steps of the AP process, including an example of an automated AP workflow.