This article is part of a larger series on Bookkeeping.
Revenue is the amount your business receives for the sale of goods and services, whereas gross profit is the amount remaining after the cost of goods sold (COGS) are subtracted from revenue. Net profit, or net income, is the remaining amount after operating expenses are subtracted from gross profit.
Revenue – COGS = Gross Profit – Operating Expenses = Net Profit
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Total Operating Expenses
There are a few distinct differences between revenue and profit, which are described below. We also recommend when to use each.
What Is Revenue?
Revenue is the money generated from normal business operations and is also known as sales on the income statement. For retailers, revenue is generally the number of units sold times the sales price. For service providers, revenue is the number of hours billed times the hourly rate. Of course, many businesses vary from these basic models, but revenue is whatever you collect from your customers prior to deducting any costs.
Accrued revenue reflects the earnings from providing a product or service, where payment has yet to be received. Because of this, it’s recorded as a receivable on the balance sheet to show the amount that the customer owes the business for the products or services that they purchased. Accrued revenue is often monitored by businesses that are engaged in long-term projects, such as a construction company.
Deferred revenue is money received in advance for products and services that are going to be performed in the future. It’s also known as unearned revenue, recorded as a liability on the balance sheet and is common with subscription-based products or services that require prepayments. As the product or service is performed over time, revenue will be recognized and the unearned revenue liability will be decreased.
Examples of Revenue
- Accrued revenue: Accounts receivable and income earned for projects not yet billed
- Deferred revenue: Rent payments received in advance and annual subscription payments received at beginning of year
Revenue Is a Useful Measure For
- Assessing the growth or size of a company: Revenue is a good metric to gauge a company’s growth and size. It is best used as a measure of growth and size when comparing similar companies in the same industry.
- Determining if pricing strategy is maximizing revenue: A price maximization strategy attempts to make pricing decisions that generate the greatest revenue for the company. Reviewing how total revenue varies with pricing changes is the first step in creating this type of strategy.
- Examining trends in sales: Examining trends in sales over time allows business owners to discover trends, such as whether their customers purchase more on certain days. They can also review monthly sales to determine if the company’s volume fluctuates seasonally.
- Calculating taxes owed: In some jurisdictions, tax preparation requires sales revenue measurement. Often referred to as a gross receipts tax, some states and localities require businesses to pay a certain level of tax calculated on each dollar of sales that the company makes.
What Is Profit?
Profit is the money earned by a business when its total revenue exceeds its total expenses. To calculate profit, subtract the company’s expenses from its total revenue over a fixed amount of time. If the value that remains after expenses have been deducted is positive, the company is said to have a profit. If the value is negative, it’s said to have a loss. Learn more about how your profit factors into your profit & loss (P&L) statement.
Gross Profit vs Net Profit
Gross profit subtracts only the direct cost of producing goods from the total revenue, whereas net profit or the bottom line, which reflects the overall health of the business, is the money left over after subtracting operating expenses from gross profit. The gross profit helps companies learn how much money they have made after accounting for the direct costs associated with creating their product or service.
- To calculate gross profit, subtract the COGS from total sales
- To calculate net profit, subtract your operating expenses from your gross profit
Gross Profit Is a Useful Measure For
- Measuring how efficiently companies make money from products and services: Gross profit measures profit as a percentage of sales revenue.
- Determining if sales price is adequate: Managing gross profit helps a business avoid problems with prices that are too low and direct costs that are too high.
- Identifying if you’re paying too much for goods or labor: Fluctuations in your costs of goods and labor will be reflected in your gross profit. If these costs increase without a corresponding increase in revenue, you may be paying too much and gross profit will suffer.
Net Profit Is a Useful Measure For
- Evaluating your company’s overall health: Net profit provides the bottom line number to determine if your business is making money. If you’re falling short in this area, it may be necessary for you to develop a clear plan for growth.
- Knowing if the company can continue operating: Net profit helps you to understand not just how much money you’re bringing in but how profitable you are. If you’re bringing in revenue but aren’t profitable, you may need to evaluate your business model and strategies.
- Planning for the future: If your business is profitable, you may want to think about how you can use some of the money to further grow your business by hiring more employees or increasing your marketing budget.
Rather than tackle your company’s bookkeeping yourself, you may want to look into hiring a professional bookkeeper. Read our guide on what bookkeeping is and what bookkeepers do for more information.
Frequently Asked Questions (FAQs)
Is profit more important than revenue?
While both are important, net profit gives a more accurate picture of a company’s financial position because it takes into account all the expenses incurred to generate the revenue.
Can profit be higher than revenue?
No, this would mean that you have a negative COGS or operating expenses. Profit is always lower than revenue because expenses are always positive.
Revenue is the total income amount that is generated by the sales of goods or services while profit is the amount of income that remains after accounting for all additional income streams, operating costs, and expenses. Understanding how both revenue and profit affect your business is key to its success.