Considered the most important metrics for businesses and investors alike, revenue and profit measure a business’s income. This, however, is where the similarities end. Let’s uncover what each one is, their differences, how each is calculated, and their effects on the financial health of the business. We’ll also explore other key financial metrics, common revenue vs profit misconceptions, and provide tips on how you can improve both revenue and profit.
Understanding Revenue vs. Profit
While both revenue and profit refer to the money a company earns, revenue – the top line – is the amount of money the company earns before expenses are deducted. So, what is profit, and how does it differ from revenue? Investopedia defines revenue as the money brought into a company from business activities over a specified period of time. The need to be sensitive to pricing is a critical component in determining a company’s revenue.
Sometimes called net income, profit is revenue minus the expenses incurred. In other words, profit describes the financial benefit realized when revenue generated from a business activity exceeds the expenses, costs, and taxes involved in sustaining the activity in question. Profit is used by businesses to help set reasonable price points, as well as to operate leaner and manufacture goods more cost effectively.
Let’s dig deeper into revenue and profits – since distinguishing between the two is critical for accurate financial analysis and business strategy formulation.
Calculating Revenue
Revenue is calculated by adding all money taken in by sales and other sources of income during a particular time – month, quarter, annual. For example, let’s assume that during the month of May a PR services agency sells 4 media training programs at $1,500 per session, created 10 byline articles at $800 an article, and conducted 7 analyst briefings at $1,200 a briefing. We’ll also assume that the company earned $150 interest income from its bank savings. The gross revenue for May would be $22,550.
Revenue = Sales + Interest Income (depending on company type)
(4 x $1,500) + (10 x $800) + (7 x $1,200) + $150
Note: Interest earned is included in the above calculation since the PR agency is considered a professional services business.
Calculating Profit
Stated as a percentage, profit is calculated by subtracting all expenses from sales and dividing the result by the sales figure. Let’s return to our PR services example where gross revenue for the month of May was $22,550. We’ll assume that total expenses for the month amounted to $14,000, which provides the organization with a 38% profit
(Sales – Expenses) / Sales = Profit
($22,550 – $14,000) / $22,550 = 38%
Revenue vs. Profit: What are the Differences?
Revenue is the amount of money a company brings into the business, whereas profit is the amount of money the company retains after all expenses, such as the Cost of Goods Sold (COGS), selling, general and administrative expenses, operating expenses, depreciation, interest, taxes, and other expenses have been deducted.
Let’s itemize a few of the key differences between revenue vs profit and how each is used.
Revenue:
- Money the company earns from its operations.
- Used by companies to project future revenue.
- Typically susceptible to bookkeeping variations.
- Considered a purer figure than profit.
- Reported near the top of the income statement.
Revenue (aka sales) doesn’t include the deduction of costs associated with operating the business. Gross revenue, however, is the total sales less returns or discounts, whereas net revenue doesn’t include company expenses.
Profit:
- Money the company retains after deducting expenses.
- Profit projections rely heavily on management projections.
- Companies rely on profit percentages when determining capital allocations.
- Reported further down within the income statement.
Note that while a company can generate revenue, it may also encounter a net loss during the same time period. It’s also important to realize the differences between gross profit, operating profit, and net profit.
- Gross Profit: Calculated by subtracting the COGS from total revenue (aka gross sales).
- Operating Profit: Calculated by deducting operating expenses from the gross profit.
- Net Profit: Calculated by deducting interest expenses and taxes paid during the specified period from the operating profit. This is the figure that is left over after all expenses have been deducted.
The bottom line (profit) signifies the financial growth or decline of the company. Increasing profits signal that the company is growing. Declining profits need to be quickly investigated as they could be a sign of financial difficulties. While revenue vs profit are vital figures in monitoring the financial health of the business, there are other metrics that need to be tracked.
Key Financial Metrics
Do you know the key financial metrics to analyze a company? Financial metrics serve as key performance indicators (KPIs) that help companies evaluate their financial standing, provide input in setting and meeting goals, and proactively identifying issues. Let’s define the terms and how to calculate each one:
Gross Profit Margin
Used to identify the percentage of revenue remaining after deducting COGS, this metric measures the profitability and efficiency of a company’s business operations.
Gross Profit Margin = (Net Sales – COGS) / Net Sales x 100
Net Profit Margin
Measures profitability by analyzing the percentage of revenue and other remaining income after all costs are subtracted.
Net Profit Margin = Net Profit / Revenue x 100
Return on Sales
Typically used to determine the efficiency of turning revenue into profit, it measures the amount of operating profit generated from each dollar of its sales revenue.
Return on Sales = (Earnings Before Interest and Taxes / Net Sales) x 100
Operating Cash Flow Ratio
Leverages data from the company’s cash flow statements, it measures the business’ ability to use profits to pay for short-term expenses.
Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities
Working Capital
Used to determine a company’s ability in meeting financial obligations, this metric compares a company’s current asset with its current liabilities.
Working Capital = Current Assets – Current Liabilities
Current Accounts Receivable Ratio
Analyzes the total value of unpaid invoices to the total balance of all accounts receivable to measure the extent to which customers pay invoices on time.
Current Accounts Receivable Ratio = (Total Accounts Receivable – Past Due Accounts Receivable) / Total Accounts Receivable
Customer Acquisition Cost
Customer acquisition cost (CAC) includes the costs (marketing & advertising expenses, sales costs, software, and operational costs) in acquiring a new customer.
CAC = Total Marketing and Sales Costs / Number of New Customers Acquired
Customer Lifetime Value
Customer lifetime value (CLV) provides an estimation of revenue a customer will generate throughout their relationship with the business.
CLV = Average Purchase Value x Purchase Frequency x Customer Lifespan
EBITDA
Used in company valuations and profitability analysis, Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is typically used as an indicator of operating performance.
EBITDA = Revenue – Operating Expenses – Taxes – Interest Expense
Operating Income
This is similar to EBITDA. Operating income is a measure of a company’s profitability and operating income (aka earnings before interest and taxes (EBIT)). It reflects a company’s total revenue minus operating expenses within a certain time period.
Operating Income = Revenue – Operating Expenses – Depreciation & Amortization Expense – Taxes – Interest Expense
Basically, EBIT is a measure of profits that excludes non-cash expenses, while operating income is a measure of profits that includes non-cash expenses.
Revenue vs Profit: Misconceptions and Common Mistakes
What are the best strategies for improving profit margins? Undoubtedly the most common misconception is that revenue vs profit are synonymous. While both are important financial metrics that are used to measure the success of a business, they are not the same. Revenue is the amount of money that a business brings in from the sale of products or services. Profit is the amount of money remaining after expenses have been paid.
It’s entirely possible for a business to have high revenue and a low profit. To put this in perspective, think business expenses – high COGS, high overhead, high marketing/advertising costs, etc. will all drive profits down. Similarly, selling products and services at a high price may result in a high profit margin but the company may experience low revenue. Alternatively, selling products and services at a low price may drive high revenue but the company may have a low profit margin.
Common Mistakes
What are the best strategies for improving profit margins? To improve revenue and profitability, avoid these six common mistakes:
- Irregular Tracking of Revenue vs Profit: When revenue and profit aren’t regularly tracked, companies don’t have a clear financial picture and are at risk of making uninformed business decisions.
- Focusing on Revenue Only: While both revenue and profit are important financial metrics, focusing on increasing revenue only can negatively impact profit.
- Setting Prices Low or High: A company’s pricing strategy can have a direct impact on profit. When prices are set low, the company may have high revenue but a low profit margin. Similarly, prices set high may result in a low sales volume, resulting in low revenue but a high profit margin.
- Understanding Low Profit: When profit dips, it’s important that the company conduct a complete analysis to understand the root cause so that measures can be taken to improve profitability.
- Disregarding Competition and Market Trends: Making informed business decisions requires ongoing monitoring of the competition and market trends. Ignoring either can result in missed financial opportunities, the inability to make informed business decisions, and unnecessary or unanticipated challenges.
- Ignoring Long-Term Implications: Financial decisions need to be made for not only attaining short-term gains goals, but long-term implications need to be considered to ensure ongoing revenue and profit.
Boost Revenue and Profit
Increasing revenue and profit isn’t as easy as developing a product or a service and assuming customers will come. Companies can have the best products or services and still find themselves on the low end of revenue and/or profit. While increasing revenue and profit takes some forethought, it can be done.
Although revenue and profit are different, they are related.
Top Strategies to Implement
While it’s important for every industry, SaaS companies specifically need to track both revenue growth metrics (like MRR vs ARR) and profitability indicators (profit margin, EBITDA) for long-term success. Take a look at some strategies you can implement today to improve revenue and profit.
- Track Revenue vs Profit: Revenue and profit need to be tracked regularly to identify trends and make informed business decisions.
- Increase Total Sales: Offer marketing and/or advertising initiatives or increasing sales personnel can quickly increase total sales plus build the pipeline for continued growth.
- Diversify Revenue Streams: Offer a range of products and/or services. This lessens the impact of market fluctuations and enables the company to proactively respond to evolving customer needs.
- Optimize Prices: Using market research, cost analysis, and customer feedback enables companies to determine market-acceptable prices for products and services.
- Increase Efficiency: While there are numerous ways to improve efficiency, streamlining processes, automating tasks, and determining how to do more with less, such as outsourcing time-consuming tasks should be the first areas investigated.
- Reduce Finance Charges: Start by paying down outstanding debt and/or refinancing debt at a lower interest rate.
- Outsource Time Consuming Tasks: Time consuming tasks can be outsourced, enabling you to reduce personnel or use the resources for revenue-generating activities.
- Optimize CAC:CLV Ratio: CAC can be lowered by focusing on organic growth channels, refining targeting strategies, and investing in referral programs. Increase CLV by building stronger customer relationships through regular communication, exceptional support, and delivering value-added services. A healthy CLV:CAC ratio is considered 3:1. That means the revenue generated from a customer is three times higher than the cost to acquire the customer.
- Leverage Revenue Management: Increase revenue and profit with revenue management. This requires a system that centralizes revenue streams, automates revenue calculations, and helps close books faster.
Profit vs Revenue: BillingPlatform Has You Covered
Legacy billing and revenue management systems simply can’t keep pace with the way business is handled today. That means revenue and profit are not being optimized. Recognized by Gartner® and MGI Research as a market leader for automated revenue management solutions, BillingPlatform has the solution and expertise to put you on track to improved revenue and profitability. Contact our team to learn more about how we can help you today.
