One of the trickiest distinctions to make when it comes to managing your business is the difference between revenue vs profit. There are a few simple rules for determining which is which. One of the hard and fast rules is that profit will never exceed revenue, and it is typically less. To put it plainly, profit is revenue minus expenses — although in reality, it’s quite a bit more complicated than that.
At its simplest, revenue is positive cash flow. Any source of income for your business is revenue — whether it is liquid cash, checks, dividends, capital gains, credit card receipts, or in some cases even inventory acquired through acquisitions of a competitor.
Revenue is a large concept, but it can be boiled down to any source of money that flows into a business or personal account.
On the balance sheet, all revenue is accrued under the heading of ‘Accounts Receivable.’ These entries show every source of income from sales that come into your business. Money that comes in due to sales, auctioned assets, appreciating assets, and investment income. In short, revenue is every transaction that results in a positive accrual of money for your business.
The most basic explanation of profit is any revenue minus expenses. It’s not always that simple of course, since expenses can take quite a few different forms, but at the end of the day the way that you find how much profit your business is making is to subtract total revenue from total expenses. There are a few different types of profit, depending on exactly how much is subtracted from gross revenue.
The first type of profit that businesses concern themselves with is gross profit. Gross profit is simple revenue minus inventory expenses. For example, if you operate a retail store, you can find your yearly gross profit by subtracting the money that you have spent on stock for the year from the total amount of money that you have made all year. Again, gross profit does not tell the whole story, but it can be a useful tool for quickly examining your finances to see how profitable your business would be if you ignore all other expenses.
Operating profit is similar to gross profit, but it takes many other costs into account. In order to find your operating profit, you first figure your gross profit as we explained above. Then you subtract operating costs like rent, labor, utilities, and other fixed costs. That leaves you with your operating profit.
Finally, net profit is the amount of money that is left in your account at the end of the year after subtracting every single business-related cost from your revenue. In order to find your net profit, first, you have to calculate your operating profit. After you know what your operating profit is, you subtract one-time expenses. Some examples would be an advertising campaign that your business tried once and decided not to continue, legal fees, and various other rebates, and irregular expenses. At this point, if you had not added them into your revenue earlier, you can also add one-time profits like the sale of assets, special offers, or other one-time business transactions that net your business money.
There’s no question that knowing the difference between revenue vs profit is critical to every business. Everyone wants to know how much money their company has taken in over the course of the year. However, splitting revenues and profits into logical groups also makes it easier for management to see exactly where they are losing money — or gaining it — without having to examine the financial ledger line-by-line. A good business will keep track of revenue, gross profit, operating profit, and net profit along with an easy-to-read breakdown of each. Trust me, at the end of the year, your accountant will thank you.