In most cases, running a business is all about survival. Companies scratch and claw as they try to reach the next year still intact, but the odds often feel stacked against them. According to the Bureau of Labor Statistics, about 20 percent of companies that started in 2015 failed within their first year. By the time 2020 rolled around, that number reached about 50 percent.
To survive, companies need to maximize their chances for profit and understand how revenue drives it. But it can be easy to conflate the two, especially in the complex business world that companies operate in. A complete understanding of both will help you run your business smoothly and lead to your organization surviving to the fifth year and beyond.
In this article, learn about the differences between revenue and profit, as well as other important metrics like gross profit, net income, accrued revenue, and more.
What’s the Difference Between Revenue vs. Profit?
Revenue is the income your company generates through the sale of goods and services from normal business operations. On the other hand, profit is how much income you have after you factor in elements such as expenses, operating costs, and debts. Revenue and profit are clearly related but provide different information as to the health of your business. Let’s take a closer look at each one.
When looking at your income statement, your company’s revenue will appear in the top spot. For this reason, people often refer to revenue as the top line. One important thing to remember is that revenue only includes income generated from the company. If a business earns money from investments, that would not be revenue. Revenue can also come from different areas of the company, such as sales revenue.
On the same income statement, profit appears at the bottom, which is why many people refer to profit as the bottom line. So when you hear someone say that they want to maximize the bottom line, you know they’re referring to their company’s profit. There are several types of profit that show up on an income statement, which will be outlined later.
Gross vs. Net Revenue
There are several types of revenue. The most common are gross revenue and net revenue. Gross revenue, sometimes called gross sales, only accounts for the total money a company earns through the sales of a good. When calculating gross revenue, a business will not factor in the cost of goods sold. So if a company sells a mattress for 500 dollars, the 500 dollars would count as the gross revenue no matter how much it cost the business to produce the product.
Net revenue, also known as net sales, looks at the total amount of money generated from operations. The difference between gross and net revenue is that revenue also looks at money lost through factors like returns, discounts, and refunds. Reporting on net revenue happens in some specific situations, such as when companies need to provide a percentage of sales revenue to a supplier.
What is Accrued Revenue?
Accrued revenue is another type of revenue calculated by taking the revenue a company will earn from the goods or services they have already delivered while the customer has yet to pay. This happens in only specific situations. A company may run a sale, for example, where the customer doesn’t have to pay for the product until 30 or 60 days later. The company still delivers the product to the customer and counts the accrued revenue for the month, even though they technically do not have that money yet. This can be a helpful tactic leaders use when scaling a business.
Moving on to different types of profit, gross profit is a significant indicator of a company’s sales performance. Gross profit, or gross income, comes from looking at how much a company earns from selling goods or services, then subtracting how much it costs to produce and sell those goods (also known as cost of goods sold or COGS). Investors like looking at a company’s gross profit because it shows how well they can manage their product costs. The more efficient a company is at producing goods, the better the gross profit will be.
Calculating gross profit is relatively simple. You take the net sales and subtract COGS. The cost of goods sold includes raw materials, inventory, worker wages, repair costs, shipping costs, and more. To have a successful company, you want to make sure gross profit remains in positive territory.
What is Net Income?
So, where does that leave net income? When people talk about profit in a casual sense, they usually mean net income. A company’s net income comes from taking all of the business’s expenses and subtracting them from its total revenue. This showcases the difference between revenue and profit. In other words, figuring out an organization’s net income requires taking the gross profit and subtracting operating expenses, debt interest, income taxes, administrative costs, and more. Accountants also factor in other sources of income to reach the company’s net income number.
When Gross Profit and Net Income Don’t Apply
The use of gross profit and net income doesn’t always work in certain situations, particularly when it comes to specific industries. As just one example, the measurement of gross profit has limitations in the service industry since, in that industry, companies tend not to produce a product and therefore do not have notable production costs. Net income may not work in a field such as real estate since sales of a property may inflate revenue numbers for a short period of time. Knowing these limitations will help you better determine how good or bad a company is performing.
More Metrics to Know
In addition to the terms discussed above, other metrics can show how well a company is doing. If you’re curious about a company’s performance or the health of your own, the metrics below can help:
- Net profit margin: This metric shows how much profit a company makes from every dollar they earn in revenue. To calculate the net profit margin, take your net income, then divide it by revenue. Take that result and multiply it by a hundred. The end result will be a percentage, which represents the net profit margin.
- Return on investment (ROI): The ROI of a company indicates how much profit the organization earned after subtracting the amount an investment is worth on the market from that investment’s original cost.
- Earnings before interest and taxes (EBIT): EBIT is one metric that investors look at closely. The earnings before interest and taxes metric show how profitable a company is without factoring in taxes or debts.
- Gross profit margin: The gross profit margin is similar to the net profit margin in that it shows up as a percentage. To calculate it, divide your gross income by revenue, then multiply the resulting number by 100.
- Operating profit: This metric takes the company’s gross profit and subtracts variable and fixed expenses that usually come from regular business operations. Those operations can include items such as payroll, rent, and utilities.
Revenue and Profit Matter but There’s More
When it comes to having a healthy, successful company, revenue and profit matter a great deal. However, a large amount of revenue doesn’t mean you have a highly profitable business. According to the latest statistics from Fortune, Walmart is the company with the most revenue in the U.S. at nearly 560 billion dollars. However, they are only the 13th most profitable organization. That’s still not a bad ranking, but high revenues don’t automatically mean profit. Airbnb, for example, rakes in lots of cash but is considered not profitable at the moment. Where you place your effort makes a big difference in your success, so following the 80/20 rule can help.
As important as revenue and profit are, they should not be the sole focus of your company. Think of a mission statement that inspires and uplifts to form the core of your business. Find ways your company can benefit your community and customers. Don’t let the search for profit drive every decision. At the same time, you want your company to survive, so don’t ignore the need for increasing revenue and profit. By balancing out these needs, you’ll put your company in a position to not only survive but thrive.
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