Business Budgeting

Revenue vs Profit: The Difference in Plain English

Author

Ziwei Chen

Content Marketing Specialist, Relay

If you make $1 million a year in revenue, but can only pay yourself a profit of $20,000, is your business successful? 🤔 The answer might actually be subjective — it depends on your goals and the stage your business is in. Yes, business success is traditionally measured by its ability to maximize profit — but that doesn’t mean we should overlook revenue as a metric. So let’s take a closer look at the difference between revenue vs profit and exactly what these metrics tell you about your business. 🔍

What’s the difference between revenue vs profit?

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

What is revenue?

Revenue is the total amount of income generated by your business from the sales of goods or services before any expenses. 💰 If you add up the total sales generated by your company, that is your company’s total revenue for the year. 📅

Revenue is often referred to as “top-line” because it sits at the top of the income statement and represents the money flowing into your company. 🔝 Depending on the type of goods or services your company sells, your income statement may look different compared to other companies. You’ll sometimes see revenue split up into product revenue or service revenue, such as in the Microsoft example below. 👇

Microsoft Income Statement

This screenshot shows Microsoft’s 2021 Q4 income statement. Total revenue is reported on the top line.

Ever heard the saying that “revenue is vanity, profit is sanity”?👂 While it’s true that profit is a critical metric, don’t 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 can’t downplay its importance. With that covered, let’s turn to the other important metric: profit.

What is profit?

Profit = Revenue - Expenses

Profit or “net income” is the total amount of money a business keeps after deducting expenses. In financial jargon, profit is often referred to as the “bottom line” as it’s quite literally the last line found on an income statement.

Aritzia Income Statement

This screenshot shows Aritzia’s 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 🤓 — 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 📈 or negative number 📉. When net profit is a negative number, it’s referred to as a loss because the company did not make enough money to cover its expenses.

Types of profit

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

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 doesn’t include other fixed costs such as rent and the salary of individuals not involved in producing a product.

Operating profit

Operating profit is gross profit minus operating expenses such as rent, payroll and utilities. Operating profit represents the total earnings before interest and taxes.

Net profit

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. It’s what your company keeps after every single expense has been paid off.

What’s more important: revenue or profit? 🤔

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 shouldn’t care about profit as much as they should about profitability. 🏆

What’s profitability and how does it differ from profit? Profitability or profit margin is the measure of your company’s 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 — if revenue from sales covers your expenses, you’re 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%.

Why profitability is more important 🥇

Profit alone can be misleading — it doesn’t show the full financial picture. Let’s 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 — 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 A’s:

    • costs would rise by $80,000

    • profit would drop to $320,000

    • profit margin is 10%

  • Company B’s:

    • costs would rise by $40,000

    • profit would decrease to $360,000

    • profit margin is 20%

Company B is more resilient to cost changes 💪🏻 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.

How to improve the profitability of your business

If you’re a business owner, you care about your bottom line. Here are some tried and true tips on how to increase profitability for your company.

Use a business budgeting method to set financial goals

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.

Improve efficiency in your business operation

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.

Compartmentalize your expenses ✉️

Organizing all your expenses into multiple accounts can help you get a clearer picture of how much your business spends, how much you’re paying taxes and how much you’re earning.

For example, you can set up different checking accounts for each of the following:

  • Payroll 💰

  • Utilities 🏠

  • Marketing expenses 👩🏻‍💻

  • Taxes 💲

  • And anything else your business needs to track 💡

If you’re looking for a business banking accounting designed to help you gain clearer insight into your business’ profitability, then Relay might be a perfect solution. It’s 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. 🚀