Revenue and profit are two of the most important and crucial metrics every business must track if it is to understand performance, plan effectively, and spend wisely, among a host of other key functions and activities.
Each term is distinct in its application and measurement, but despite these differences the two concepts are often confused. Here we are going to take a closer look at the difference between revenue and profit and see how to distinguish them from one another.
What is the difference between profit and income?
Revenue is the total income that a business generates from its sales. Profit is the part of that income that is left after subtracting operating costs, debts, taxes, and any other expenses that it incurs in the interest of generating income.
You must have a consistent image of your business income and profit if you want to reliably assess its financial health and viability. Both metrics can be indicative of the effectiveness of your sales and marketing efforts as well as the effectiveness of your spending.
It takes a few steps to reduce your sales to your profit. Let’s see how you can switch from one to the other.
How to go from income to profit
Start with gross sales
The gross sales of a business is the most basic measure of the revenue it generates – without factoring in allowances, discounts, and returns. It is the product of the number of units of a product or service sold by a business and the price at which those units are sold.
In some ways it could be considered a type income – but this does not accurately reflect the income of a business and is usually not shown in an income statement.
Shift from gross sales to net sales
Net sales are a much more practical reflection of a company’s overall sales. It takes into account all the sales made by a business, but takes into account three key factors that affect the price at which a product or service can be sold:
- Allowances – Retroactive discounts that a buyer receives after discovering and reporting some kind of defect in a product.
- Discounts – Price reductions that a seller offers to a buyer in exchange for immediate or early payment.
- Return – Partial or full refunds buyers receive for returning a product to a buyer.
Once these elements are integrated into a company’s financial reporting, it has a clearer picture of its real income. For more information on the difference between gross and net sales, check out this article.
Go from net sales to gross profit
Once you have established your net sales, you can calculate your gross profit by subtracting the cost of goods sold (COGS) – costs directly related to the manufacture of your product, including raw materials and labor – of your net sales.
Going from gross profit to profit before interest and taxes (EBIT)
After calculating your gross profit, you reduce that figure to profit before interest and taxes (EBIT) (also known as operating profit) by subtracting your operating costs – the costs associated with the resources on which your business operates. ‘support to stay operational, including employee salaries, rent, legal fees, selling costs and marketing costs.
Go from EBIT to net profit
As you can probably assume, you can find your bottom line profit by subtracting the value of any interest or taxes you incur from your income before interest and taxes. This final figure is the most accurate reflection of the profitability of your business over a given period.
Example of income vs. profit
Start with gross sales
Let’s say a manufacturer placed 5,000 orders for 1,000 units at $ 1 per unit in the past fiscal year. In this case, the gross sales of the business would be $ 5,000,000.
Shift from gross sales to net sales
Now imagine that out of those 5,000 orders, 100 buyers reported defects and each received an allowance of $ 0.15 per unit. Another 100 received a rebate of $ 0.05 per unit for paying for their entire order when they first purchased. And another 100 returned their purchase for a refund of $ 0.50 per unit. This would mean that the company would have to report:
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$ 15,000 in allowances
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$ 5,000 discount
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$ 50,000 in returns
Together, these deductions would increase the gross sales of the business by $ 70,000, resulting in net sales (or sales) of $ 4,930,000.
Go from net sales to gross profit
From there, the company subtracts its COGS from its net sales to get its gross profit. Let’s say it takes $ 0.25 in raw materials and labor costs for the company to produce each individual tennis ball – so the COGS for the 5,000 shipments the manufacturer moved would amount to approximately $ 1,250,000. This would make the gross profit of the business of $ 3,680,000.
Going from gross profit to profit before interest and taxes (EBIT)
Once the manufacturer had its gross margin, it would find its profit before EBIT by subtracting its operating costs. Suppose the company spends $ 2,500,000 per year on employee salaries, $ 200,000 per year on rent for its facilities, $ 100,000 on marketing efforts, $ 15,000 on accounting costs and $ 10,000. in travel expenses for its salespeople.
Assuming that is all it takes to keep the business operational, its operating costs would be $ 2,825,000. That would make the company’s $ 855,000 EBIT.
Go from EBIT to net profit
Once its earnings before interest and taxes are established, the business would find its bottom line by subtracting (you guessed it) the interest and taxes it pays. Let’s say these fees amount to 35% of the company’s revenue. This means that the company would pay $ 299,250 in tax interest, which would make a net profit of $ 555,750.
As you can see, there is a pretty big gap between the company’s revenue ($ 4,930,000) and its bottom line ($ 555,750).
Every business must distinguish between turnover and profit. The two measures have different practical applications and varying implications for the health of your business.
Originally posted Jan 12, 2022, 7:00:00 AM, updated Jan 12, 2022
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