Revenue vs profit is perhaps the biggest distinction to make when reviewing financial metrics for any company, regardless of the type of business or industry. You need to know your revenue and profit figures to track performance properly, forecast accurately, and lead your company. Yet revenue vs profit is often used interchangeably, which means some may need some clarity around the two terms.
To help clear the confusion, here’s a brief overview of profit vs. revenue, their differences, and how you calculate both.
What Is Revenue vs. Profit?
So what is revenue vs profit? Revenue is the total income generated by a business. Revenue is typically created via sales of products and services. Still, other business activities such as licensing agreements can also bring in revenue.
Profit, on the other hand, is the remaining portion of total revenue that remains after subtracting all of the company’s expenses. This includes normal operating expenses, payroll, taxes, debt payments, and anything else the company spends its income on.
When discussing revenue vs profit, a common mistake is to call income “profits.” You’ve probably heard someone say something like, “We spent all our profits on x, y, and z.” In those cases, they’re most likely referring to their revenue—the money the business took in over a given time period.
While it would be great if all of a company’s income was profit, that’s never the case. Every business has expenses. The goal is to have substantially more revenue than expenses, creating a hefty profit. Significant profits can be reinvested back into the business, expanding the company in the pursuit of more sales. That’s why discussions of profit vs. revenue examine both figures separately.
Revenue vs Profit: How To Calculate Profit from Revenue?
Calculating your company’s profit is not as simple as subtracting total expenses from total revenue. That’s because the total revenue figure can be slightly misleading. For better accuracy, instead of simply considering revenue vs gross profit you need to follow some steps to calculate the figure known as “net profit.” Here’s how you do that.
Step 1: Start with Gross Sales
A company’s total revenue is known as its gross sales. Think of gross sales as the number of products or services sold, multiplied by the price of each product or service.
You typically won’t find gross sales on an income statement, because it doesn’t take into account some of the real-world factors that come into play. To overcome this, you next need to convert your gross sales figure into net sales.
Step 2: Calculate Net Sales
The factors that are considered in net sales are discounts, returns, or allowances. Here’s a quick look at how those terms are defined:
- Discount: A reduction in price offered in exchange for early or immediate payment.
- Returns: Full or partial refunds given to buyers for returning a product.
- Allowances: Retroactive discounts given to a buyer after they report a product defect.
Once these three factors have been subtracted from your gross sales, you have your net sales figure.
Step 3: Calculate Gross Profit
Next, you need to figure out the cost of goods sold (COGS). These are the costs directly associated with the production of your products, like raw materials and labor. Subtract COGS from your net sales, and you now have your gross profit.
Step 4: Calculate Operating Profit
Now that you have your gross profit, you need to subtract operating costs. These are all the costs incurred in keeping a business operational: employee salaries, rent, sales expenses, marketing costs, legal fees, and the like. After subtracting operating costs from gross profit, you have your operating profit. This is also known as EBIT—earnings before interest and taxes.
Step 5: Calculate Net Profit
The final step is to take your operating profit figure and subtract the sum of any interest and taxes your company pays. You have now arrived at your net profit figure, the most accurate reflection of profitability.
What Your Net Profit Figure Tells You
Even though it takes a few steps and calculations to figure out the net profit, it’s critical to understanding the business’ health. Net profit gives you a more accurate picture of how much money your business actually earned in a given time period.
With the net profit figure, business owners and investors are in a better position to evaluate the financial performance of the company. Instead of relying on raw revenue numbers as a benchmark, you can now make informed decisions about growing your business or cutting costs.
In addition, net profit is a metric used by banks and other financial institutions when making credit decisions. A high net profit margin tells the bank that your business is more likely to pay back loans. A low or negative net profit is seen as an indication of financial instability or poor management.
Revenue vs Profit vs Income: inDinero Helps With All the Metrics
Informed business leaders are armed with many metrics that guide their decisions. When you understand your revenue vs income vs profit, you know when to expand your company’s reach—and when to do some belt-tightening. If you need help building up your metrics, the experienced team of experts at inDinero is here to help. Contact us today to see how inDinero can help with all of your company’s metrics.