It’s important to know what each of these terms means when analysing the financial health of your startup. You can’t effectively manage your company’s finances unless you make the distinction between the two.
Many people confuse profit and revenue, but the two are not the same thing. Thus, using the two terms interchangeably can lead to serious problems in financial reporting and planning.
Let’s take a look at the various definitions of cost, revenue, and profit, as well as their respective methods of calculation and importance.
Cost
Input costs are necessary for any business. Every facet of manufacturing has its own set of costs. Wages and benefits are the standard units of measurement for the cost of labour in the manufacturing of a product or service.
Depreciation of a fixed asset occurs while the asset is in use. The cost of financing the acquisition of fixed assets is commonly used as a proxy for the interest cost incurred when financing a capital raise.
Knowing how much things cost is essential for running a profitable company. Oftentimes, a company’s expenses can be tallied with little difficulty. Accordingly, there is a one-to-one connection between output level and input price.
Other costs must be estimated or assigned as well. The input-output connection can be inferred without resorting to measurement or observation.
In the provision of professional services, for instance, the quality of output is often more important than the quantity, and output cannot be simply measured by the number of patients treated or students taught.
Thus, when qualitative factors are taken into account as a significant part of measuring output, there is no direct correlation between costs incurred and output achieved.
TIP: A drop-shipping company can be started with very little capital. Having a sales channel, locating suitable product suppliers, and handling orders is all that is required.
Revenue
The money coming in from the sale of products and services is what is known as revenue for your company. Interest, fees, and royalties are some additional potential sources of income. As a result, income is typically reported on a monthly, quarterly, or yearly basis.
If a service provider invoiced $50,000 in services in March, it would have generated $50,000 in revenue for the month. Therefore, this company is owed $50,000 but will not receive any cash. In accounting, revenue equals the amount that has been billed to a client.
Invoices sent to customers and payments made in cash at the time of purchase can both contribute to a company’s revenue stream. All of these should be counted as earnings for that time frame.
The income statement for March would show a top line of $50,000 in revenue. The term “revenue” is frequently used in other contexts by businesses. For instance, you could state that one product brought in more money than the others. Additionally, you can inquire about the total revenue generated from a specific contract or client.
In these cases, “revenue” may not indicate a specific time frame, but rather income or earnings. Expenses and costs are never factored into a profit or income. Revenue is the money earned by a company.
If you were working on a project and you signed a contract to provide a service to a single client at a price of $25,000, that contract would account for all of your project’s revenue.
Profit
A company’s profit is the amount of revenue retained after deducting all operating costs. Making a profit requires charging more for the product or service being sold than the supplier pays out in production costs.
In the aforementioned revenue example, one contract was worth $25,000. If the total cost to provide the service is $20,000, your company will make a $5,000 profit.
If we look closely, we can identify two distinct kinds of gain. Both gross and net profit are included. Both the gross profit margin and the net profit margin depend on these two numbers.
Gain in Value
Subtracting the price of goods or services sold from the total amount received in exchange for those goods or services yields the gross profit. Remember that the costs of making your goods or providing your services are subtracted from your gross profit.
Proceeds After Taxes
Net profit differs from gross profit in that it accounts for all business expenses, not just those incurred directly. The additional costs include payroll, taxes, and utility bills.
How to Figure Out Sales, Income, and Profit
To figure out how much money was made from sales, multiply the price of each good or service by the number of items sold. If an orchard sells 200 apples for $2 each, the sales will bring in $400. If it also sells 100 lemons for $3 each, that’s an extra $300 in sales.
Profit is found by taking total revenue and subtracting total costs. To continue with our apple orchard example, if it costs $1 to grow and harvest each apple and $2 to grow and harvest each lemon, and the orchard sells 200 apples and 100 lemons, its total cost is $400.
To get the profit of $300, take the total amount made from sales, which is $700, and take it away. The apple sales brought in $200, and the lemon sales brought in $100.
Why sales, income, and profit are important
Businesses and investors can both learn about a company’s health by looking at its revenue and profit. Profit shows how much value a business gets out of its prices and costs. Sales revenue shows how much people are willing to pay for something. Profit and sales revenue both show how profitable a business is.
What makes revenue different from profit?
Here are the main ways in which revenue and profit are different:
There is no profit if there is no income.
Profitability is only based on how much money a business brings in. If you don’t sell anything, you won’t make any money.
The same is true for a business that brings in money but doesn’t make a profit because its costs are higher than its income.
Revenue and profit go hand in hand, and you can’t have one without the other. If you don’t make any money, you don’t have any revenue.
Your income statement shows your income and profit.
Profit and revenue should both be on your income statement, whether it’s for the IRS or for your own use.
The income statement starts with “revenue,” which is when money comes in from selling goods or services. This is where all calculations start. If there is no income, there is no profit.
Profit, or more specifically net profit, is at the bottom of the income statement because it is the result of all the work. Profit is more often called the bottom line, which is a more common term.
Revenue is affected by things outside of the company.
How much money you make depends on how many customers you have and how willing they are to pay for what you sell or do.
Even though you can make choices inside your business to make more money, most of what makes money is what happens outside your business.
Profits are based on forces inside the business.
On the other hand, profit is determined by things inside the business. To cover costs, you need enough income, but you have full control over these costs.
The more you can reduce the amount you have to take out of your income, the higher your profit margins will be. You will have a bigger profit margin if you streamline production, cut overhead costs, limit labour costs, or do all three.
One Last Thing
To understand how economics, business analytics, and accounting work, you need to know the differences between cost, revenue, and profit. Each is used to figure out how healthy a company is as a whole.
The cost, revenue, and profit numbers on an income statement are very important.
Since sales are the top line, profits are called the bottom line. Even though these two numbers are important when making investment decisions, investors must remember that revenue is the amount of money a company makes before it pays its bills. For a company to figure out how much money it made, it has to add up all of its costs, such as wages, debts, taxes, and other costs.
