Profitability vs. Revenue: Understanding the Difference
Knowing the difference between profitability vs. revenue is important when dealing with money, and running a business. Revenue is the total amount of income a company generates through its primary business activities, and after deducting all debts, expenses, and taxes, profit is the amount of income that remains from the overall revenue. Understanding revenue and profit can increase your financial literacy and positively affect the outlook of a company. In this article, we review profitability vs. revenue, and how to calculate the different types of profit and revenue to have greater success in a company.
Profitability vs. revenue
Profitability vs. revenue are two of the most important aspects of business and work together as the catalysts of every company. To have a successful business, it's important to manage both revenue and profit in relation to one another. Both revenue and profit are equally important terms to familiarize yourself with when operating a business. When it comes to finances and creating a budgeting plan, revenue and profit are essential to prioritize.
Revenue is the overall sum of income gained by selling a company's products or services. It's the entirety of a company's sales. After calculating the cost of goods sold, profit is the amount of money that's leftover. These remaining expenses can include elements such as shipping fees, product donations, or production expenses. Ultimately, profit and revenue refer to the amount of money a company makes, but the difference between profit and revenue lies within the amount of money that is taken into an account at the end of every sale.
What is revenue?
Revenue, also known as the top line, because of its position at the top of the balance sheet, is the money collected from the company's sales before deducting any additional costs. This also includes any returned items or discounts on merchandise. The reason revenue is at the top of a balance sheet is because it's the first number that goes through a series of deductions moving forward to the total profit number.
Some companies also receive revenue for their products, or services sold by increased interest or royalties. Consider revenue as any money that's received as a part of the primary business activity, and the overall amount of money that is made from a business with no deductions. Here are some other considerations when exploring revenue:
Calculating the different types of revenue
The formula for determining revenue is:
revenue = sale price x quantity of units sold
For example, if you own a retail clothing store and you sell 50 T-shirts for $20 each in one month, your revenue/top line from selling T-shirts after using the formula given above would be $1000.
There are two methods to calculate revenue, known as accrual and cash. They're defined as:
Accrual accounting: Accrual accounting is a method that calculates revenue based on payable transactions on credit. This includes sales that the business does not receive immediate payment for, but they still record the transactions on the company's balance sheet as sale revenue.
Cash accounting: Cash accounting is a method that calculates revenue based on recording only the completely received and finalized payments. You can't account for revenue as a legitimate sale in cash accounting until the transaction or payment is fully complete and in your account.
Departments of revenue
There are typically two departments of revenue that generate sales. These departments play important roles in understanding revenue and are most commonly known as:
Operating revenue: The received income from the company's primary business activity, also known as recurring revenue. For example, a florist receives operating revenue from their flower sales.
Non-operating revenue: The received income from other aspects than the primary business activity. It's the unreliable income that's the result of a financial windfall from investments or the one-time sale of an asset.
What is profit?
Profit, also known as the bottom line, because of its position at the bottom of the balance sheet, is the amount that's left over once the expenses, costs, taxes, rent or mortgage, payroll, utilities, and any other operating expenses are deducted from the revenue. The final number at the bottom of the sheet is the net profit claimed by the business owner. You can pay your total profits out as dividends or reinvest them into the business to help it grow. The number on the bottom line shows how profitable a business has been for any given period.
Since the primary goal of any company is to make money, the business needs to gauge its performance by determining revenues and deducting costs to reach the profit. In a balance sheet, revenue is at the top line, and operating expenses are directly underneath the top line. The costs deducted from the top line to reach the profit at the bottom. Profit is the surplus of money remaining after you deduct the costs from any other aspects of the sales made. Here are the different types and ways to calculate it:
Types of profit
There are three major types of profit for accounting. Each type of profit reduces the overall profit amount by deducting different categories of expenses in clusters. The definition of these terms are:
Gross: Gross profit is the total amount of income a company has produced after deducting any costs, such as shipping fees, debts, manufacturing, or costs of service.
Operating: Operating profit is the profit the company generated from its primary business activity without deducting taxes, paid interest, and profits from side investments.
Net: Net profit is the total profit generated by the operation after taking out all necessary deductions from the balance sheet.
The formula for determining profit is:
profit = revenue – expenses
Using the same example where you made $1000 in revenue, you can now determine the overall profit. For example, purchasing T-shirts wholesale costs $100 and the employee's salaries cost $300, so overall you spent $400 for one month. The profit/bottom line from selling T-shirts after using the formula given above would be $600. It's important to note that you must gain enough revenue to generate a livable profit, and to calculate the profit, you must know the revenue.
Primary vs. non-primary business activity
All businesses have a primary business activity that's their core reason for operating. A fabric store is in business to sell fabric and related items. The primary business of the fabric store is selling fabric since it makes up at least 50% or more of the store's activity. If the fabric store has small investments that account for 5% or less of the business income, those investments are not part of the primary business activity. The fabric store isn't operating as an investment firm or brokerage and the activity is less than 50% of the store's business activity.
You can separate non-primary business activity from the top line of the balance sheet and give it its own entry for accounting and taxation purposes. You can sometimes add non-operating revenue to the top line of a balance sheet, but it's usually considered a one-time gain. Non-operating business activities include business relocation, weather damage, and buying or selling capital assets.
Accurately accounting for the revenue and profit on tax documents
It's important to keep records of the profit and revenue for tax documentation purposes. Tax documents are a necessary process when documenting revenue or profit, so choosing the right calculation is so important. A business' tax documents reflect the detailed revenue and profits generated from non-primary and primary business activities. Careful calculation of taxes helps a business account for tax liabilities, ensuring all income and profit projections are accurate.
Business expenses are the costs related to a company that provides them with their income. The Government of Canada allows business owners to claim some of the business' expenses if it benefitted the business and earned them an income. It's a good idea to note and keep any record of purchases, such as receipts, coupons, and vouchers, along with the date and name of the vendor or wholesaler. It's also advisable to note that personal expenses are not the same as business expenses and you can't claim them as such. Some examples of business-related expenses include:
payroll and benefits for employees
rent and utilities for the building establishment
office related equipment and supplies
advertising and marketing
taxes and legal fees
maintenance, upkeep, and repairs