The Small Business Guide to Revenue vs. Profit
When running a small business, you’ll want to track revenue and profit. What is revenue vs. profit? Is one metric more important than the other?
While revenue and profit measure your business’s financial performance in different ways, the two metrics are closely intertwined. They are often used to gain a better understanding of your overall financial health.
What precisely is the difference between revenue and profit? Read on as we take a closer look at these two key metrics and explore how you can use them in your business.
- What is Revenue?
- How Do You Calculate Revenue?
- What is Profit?
- How Do You Calculate Profit?
- Revenue vs. Profit: What is the Difference?
- Revenue vs. Profit Example
- How Do You Increase Revenue?
- How Do You Increase Profit?
What is Revenue?
Revenue, also known as gross sales, is the total amount of money your business brings in through sales of products or services.
For example, you’d find your annual revenue by adding up the total sales for the year. It would only include the income derived from your business’s primary activities. It does not include other types of income, such as investment returns or earnings from other sources. Revenue is included in your income statement, along with gross income and net income.
Revenue and Cost of Goods Sold (COGs)
When calculating revenue, you should also consider the cost of goods sold (COGS), which are the direct costs associated with producing your product or service.
Deducting COGS from your revenue will give you your gross profit, which is the amount of money you have left after subtracting all the costs associated with creating your product or service. Since COGS is a cost of running a business, it’s recorded as a business expense on your income statement.
Revenue and Net Income
Since revenue represents the big number at the top of your income statement, it is often referred to as the “top line”. Net income, on the other hand, is known as the “bottom line”. In basic terms, net income is revenue minus expenses.
While revenue alone can’t tell you much about your business’s overall financial health, it is a valuable starting point. You can use it to understand your performance, particularly when compared to other businesses in your industry.
How Do You Calculate Revenue?
To calculate your revenue, you need to start with the average price of your product or service. Then, multiply this figure by the number of units sold. With this revenue formula, you can calculate the total revenue for the period in question.
Revenue = (average price per unit sold) X (number of units sold)
Your bookkeeper or accounting software will typically handle this calculation and report it on your company’s income statement. You will have the net sales(gross revenue minus any returns), cost of sales, and net revenue on your revenue report. By subtracting the COGS from the net sales, you will have the net revenue for the period.
For example, suppose you own a bakery that sells scones for $5.00 each, and you sell 1000 scones over a month. To calculate the gross revenue for the month, you would multiply 1000 by $5.00 to get $5,000 in total revenue.
- Example: (1,000) X ($5) = $5,000 gross revenue
You will need to deduct the direct cost of sales associated with producing the scones from gross revenue to get the net revenue. Suppose the cost of flour, sugar, eggs and other ingredients used to make the scones is $1,500 for the month.
- Gross revenue – direct cost of sales = net revenue
- Example: ($5,000) gross revenue – ($1,500) cost of sales = $3,500 net revenue
Dividing the net revenue by the gross revenue will give your business’s gross profit margin, which is an extremely important metric for evaluating profitability.
What is Profit?
Profit, or simply net income, is the amount of money your business is left with after subtracting all expenses from revenue. In financial slang, it’s called the “bottom line” since it’s represented by the last figures in an income statement.
While revenue is a critical metric for evaluating the success of your business, profit is what ultimately determines whether or not your company is sustainable in the long run. This is because profit is what’s left after you’ve covered all your costs and expenses.
You can use it to reinvest back into the business, pay dividends to shareholders, or pay yourself a salary. The higher your profits, the more successful your business will be over the long term.
How Do You Calculate Profit?
While Xendoo sends you a monthly report with your business’s updated profit and loss statement, understanding how to calculate profit is an essential part of being a small business owner.
To calculate your business’s profit, you need to start with your total revenue for the period in question. Then, deduct all expenses from this figure to get your net income.
- Net income formula: total revenue – total expenses = net income
When you dig into expenses, it can get more complex. For example, you may go a step further and factor in the EBIT (earnings before interest and taxes), depreciation, amortization, rent, and business taxes into the equation. This will give you your business’s net profit for the period.
For example, let’s say your business had total revenue of $100,000 in a year. COGS accounted for $10,000. You had $5,000 in depreciation expense, $5,000 in interest expense, and $18,500 in business taxes.
To calculate the EBIT, you’d do this:
- $90,000 net revenue – $5,000 depreciation= $85,000 EBIT
Therefore your EBIT for the year is $85,000.
- Net profit = taxable income – business taxes
- Net revenue – interest: $85,000 – $5,000 = $80,000 (taxable income)
- Example: ($80,000) taxable income – ($18,500) business taxes = $61,500 net profit
Revenue vs. Profit: What is the Difference?
In the simplest terms, revenue is a business’s total income, while profit is the amount of money a firm keeps after subtracting all costs.
Revenue is important because it indicates whether or not a business is generating income. However, profit is what’s left after all expenses have been deducted. It indicates the overall success of a business.
If you’re running a small business, it’s critical to understand the difference between revenue vs. profit to make informed decisions about how to grow your business. A business can be generating a significant amount of revenue but still be operating at a loss if it is spending a lot of money on expenses.
While a single dip in revenue or profit is common, a long-term trend of high revenue but low profit is much more dangerous. If profit is consistently low, it could indicate that your business model is not sustainable. Without a strong understanding of revenue vs. profit, it can be challenging to assess your business or make smart decisions about how to invest in its future.
Revenue vs. Profit Example
To help you better understand the difference between revenue vs. profit, let’s take a look at some examples. When public companies release their annual reports, many feature their revenue numbers prominently on the first page.
To understand revenue, let’s look at Microsoft’s financials for 2021. In their annual report, Microsoft reported total revenue of $168,088 million from product and service sales.
Product revenue accounted for $71,074 million while service and other accrued $97,014 million totaling the $168,088 million. Microsoft’s revenue increased by 17.5% from 2020 when they reported $143,015 million in product and service sales.
To understand revenue vs. profit, let’s look at Microsoft’s annual report again. Only this time, we’ll look at net income. The figure appears at the bottom of the income statement, which indicates how much profit a company has earned after accounting for taxes and all expenses.
Microsoft’s net income was $61,271 million in 2021. This was an increase from 2020 when they reported $44,281 million in net income. But how did Microsoft get to this number?
To calculate net income, we take the total revenue and subtract the cost of goods sold (COGS), operating expenses, interest expenses, and taxes. Microsoft reported these numbers (in millions):
- Total revenue: $168,088
- Total cost of revenue: $52,232
- Gross margin: $115,856
- Research & Development: $20,716
- Sales and marketing: $20,117
- General and administrative: $5,107
Subtracting this from the gross margin gives you an operating income of $69,916. But they also had other income of $1,186, so total income before taxes accounted for $71,102. Provision for income taxes totaled $9,831.
To get the net income, we subtract the provision for income taxes from the total income before taxes, which gives us our final figure of $61,271 million.
As you can see, revenue is just the first step in understanding how much profit a company has earned. To get an accurate picture of your business performance, you need to look at revenue and profit.
Although Xendoo provides profit and loss statements to all its customers, it’s crucial to understand where these numbers come from and what they mean for your business.
Keep in mind that Microsoft is a huge public company. Revenue and profit for a small business will likely be much simpler.
How Do You Increase Revenue?
While increasing your small business revenue is an excellent way to grow and boost your bottom line, it isn’t easy.
Every business is unique, and there is no one-size-fits-all solution to increasing revenue. However, a few proven strategies can help you increase your revenue.
- Increase your prices – If you are priced below competitors, or your prices haven’t increased in a while, it may be time to consider a price increase to drive more revenue. However, avoid very high prices as they might scare away your customers and reduce revenue.
- Boost sales quantity – In most cases, increasing your sales volume is the best way to grow your revenue without necessarily having to increase your prices. You can run a marketing campaign, boost brand awareness and outreach through online advertising, or hire a salesperson to help you close more deals.
How Do You Increase Profit?
In addition to focusing on revenue, focus on profit margins and work towards increasing them. It is relatively easy to increase profit compared to revenue, and you can do it in several ways.
- Reduce your costs – Evaluate your business expenses and work towards reducing them without compromising on quality or hurting your bottom line. You could renegotiate contracts with vendors, cut down on unnecessary expenses, or automate specific processes to reduce your costs.
- Manage your debts – Debts can significantly drag your profits and hurt your business’s bottom line if not managed properly. Work towards reducing your debts and interest payments by refinancing high-interest loans, consolidating multiple debts into one loan, or exploring government grants and tax incentives.
- Outsource tasks and services – In some cases, it might be more cost-effective to outsource certain tasks and services rather than doing them in-house. This could help you save on costs and increase your profits. For instance, you can outsource your accounting and bookkeeping to a professional service rather than hiring an in-house accountant.
Revenue and profit are two metrics that every small business owner should track. There are important differences between revenue vs. profit. While revenue is a valuable indicator of how much business you are doing, profit determines your long-term sustainability.
It is crucial to understand the key strategies and tactics that can help you increase both your revenue and profit margins. Whether it is increasing your prices, boosting sales quantity, or reducing costs and debt, there are several ways that you can grow your business’s top line and bottom line. The key is to stay focused, persistent, and diligent without losing track of your profitability goals.
If you want to better understand your business’s financials, Xendoo is here to help you. We are an online accounting and bookkeeping service that can help you understand your revenue and profit margins. Contact us today to get your free trial and let us get bookkeeping hassles off your plate.