When looking at the finances of your small business, you need to know the difference between cost, revenue, and profit. You need to tell them apart if you want to manage your company’s money well.
Profit and revenue are not the same thing, even though a lot of people use them that way. So, if you use these terms interchangeably in accounting and budgeting, you could make mistakes that cost a lot of money.
Cost
To run a business, you have to spend money. There are costs for every part of making something. In the making of goods and services, wages and benefits are used to figure out how much labor costs.
As a fixed asset is used to make things, its value goes down. Most of the time, the cost of capital used to buy fixed assets is used to calculate the interest cost of raising capital.
It is very important for a business to know how much it costs to run. Many businesses have costs that are easy to see and measure. So, the cost of inputs and the amount of output are directly linked.
Other types of costs need to be estimated or split up. It is not necessary to directly observe or measure the relationship between the cost of inputs and the number of units of output.
When it comes to professional services, for example, the quality of output is often more important than the quantity. Output can’t just be measured by the number of patients treated or students taught.
When qualitative factors are a big part of measuring output, there is no direct link between the costs incurred and the output achieved.
Revenue
Your business’s revenue comes from the sales of its goods and services. You may also earn money from interest, fees, and royalties. So, revenue is usually described as monthly, quarterly, or annually.
A service company made $50,000 in March if it sent out $50,000 in invoices. So, this business does not get a cash payment, but it is owed $50,000. In accounting, the amount billed to a customer is called “revenue.”
Invoices sent to customers and cash payments made at the time of purchase are both ways for a business to make money. All of these are incomes during the time period.
On the top line of your March Income Statement, you would see that you made $50,000. The word “revenue” is often used in other ways by businesses. For example, you could say that one product made you more money than another. You can also ask about how much money was made from a certain contract or customer.
In these cases, the word “revenue” may not refer to a certain time period, but rather to the income or earnings. Costs or expenses are never part of income. The word “income” just means how much money the business made.
For example, if you had one contract to do a service for a customer and the contract was worth $25,000, your income for the project would be $25,000.
Profit
Profit is simply the difference between what you earn and what you spend. To make a profit, you must make more money than it costs to provide the goods or services.
In our example of making money, a single contract was worth $25,000. If it costs $20,000 to give that service, your business will make $5,000 on the contract.
When we dig a little deeper, we find that there are two kinds of profits. Gross profit and net profit. These two numbers show what the gross profit margin and the net profit margin are.
Gross Income
To figure out your gross profit, you subtract the cost of the goods or services you sold from the money you made from selling them. You should know that your gross profit is only based on the costs that are directly related to making those goods and services.
Income
Net profit is different from gross profit because it includes all of your business’s costs, not just the direct ones. Payroll, taxes, and utilities are just a few examples of the extra costs.
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 labor 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.