Financial literacy is one of the key success tools to building a strong business. But, if you’re confused about how to run the financial side of your business, you’re not alone.
In fact, a 2014 study showed that lack of business knowledge led to avoiding financial statements — which resulted in 86% of the surveyed businesses having overall financial difficulties.
Not understanding the numbers, or the right terminology, can cost you time and money—or just leave you feeling frustrated and uncertain of which direction your business is going.
The good news is that you can take steps in the right direction now, simply by understanding the difference between revenue vs. profit and determining the roles they play in your business.
Financial literacy is one of the key success tools to building a strong business. According to recent research, 28% of small businesses that fail do so because they have problems with their finances.
Empower yourself, as one of more than 28 million small business owners in the U.S., and put your business ahead of your competition, by not only understanding revenue vs profit, but by learning how you can use that knowledge to enhance your business.
What is Revenue?
Let’s talk about what revenue is, and what it is not.
A good way to think of revenue is to think of the money your company is making, from what you sell.
A basic example would be if you had a lemonade stand, your revenue would be all of the money people paid you for your lemonade. Nothing more, nothing less.
This number does not take into account any expenses, such as the price of cups, lemons, sugar, or if you have to pay your little brother to help you on the weekends. Revenue also doesn’t take into account any investments or loans, including money received upfront, in order to get your business started.
For instance, if you sell 25 cups of lemonade in a day, at $1.00 each, your revenue would be $25.
If your business is a bit more established than a lemonade stand, you may also want to note that once a customer has been invoiced, depending on your accounting method, that money may be considered revenue— even if the customer hasn’t paid the invoice, yet. This is the case if you’re using the accrual method of accounting. If you’re using the cash method, you would not consider this revenue until the customer has actually paid the invoice.
What are Profits?
It’s been said,“Creating profit is the key to driving growth in business.”And knowing how to use profit to build your business is the starting point. Going back to our lemonade stand, we can think of profit as being the money that is made after calculating:
- Cost of Goods Sold: Cups, sugar, lemons
- Interest: Paying interest on the money your parents loaned you to start the lemonade stand
- Operating Expenses: Paying your little brother for working the stand with you
Think about it this way:
When looking over your income statements, you may notice that there are a few different types of profit, as well. The three most commonly used ones are:.
- Gross Profit
This is your total sales, minus the cost of what you sold. Total sales – price of cups, lemons, sugar = gross profit (which is also the same as Revenue – Cost of Goods Sold = Gross Profit).
- Operating Profit
This profit will show how profitable your business is, before taking into account taxes or interest (Gross Profit – Operating Expenses = Operating Profit). You’ll want to keep an eye on this number, because it shows your revenue, less the expenses you can control.
- Net Profit
Think of this as the bottom line, or the end result. You can find this number by subtracting your other expenses from your operating profit. Other expenses are typically things such as taxes and interest.
Taking all of this into account, it would look something like this:
Income Statement Pro Tip: Profit, income, and earnings can be used to mean the same thing. The key is to note whether you’re handling gross, operating, or net.
Confusion Between Revenue vs Profit
The difference between revenue and profit is literally top to bottom.
While revenue shows you the money that’s coming in, and is usually listed at the top of your income statement, the profit ( listed at the bottom) will include more aspects of your business so you can better determine how it’s doing.
One of the most damaging parts of discussing profit and revenue is that, many times, the two words are used interchangeably. We, of course, now know that this is a mistake.
This can be detrimental because a company can actually generate revenue while having a net loss. Not only does incorrect use of the terminology prove problematic for business owners taking stock of their own businesses, but it can leave investors and client’s wary.
For instance, when a business holds a sale, and is getting rid of inventory at a discounted price, it comes at a cost for the company, since the margin between the cost of goods and revenue shrinks. This means that your profits take a financial hit, and if you’re looking at your revenue, expecting it to reflect your overall profits, you can end up with the completely wrong information.
Remember: Revenue – Cost of Goods Sold = Gross Profit
While discounting and holding sales can be used to reach short-term financial goals, it can negatively affect the long-term finances of the company. It can also result in customers not wanting to buy your product at regular prices, because they’ve become accustomed to the lower rates, which can become yet another negative impact your business.
How This Relates to Cashflow
Calculating cashflow can become another point of confusion because, while it does measure the cash flowing into and out of your business, it is different from both revenue and profit. How is Cashflow Different?
- Cashflow shows the cash coming in and going out of your business, regardless of whether they are expenses, loan payments, or cash investments. Revenue will only show you the gross amount coming in from sales.
- Profits only show your financial gain, not how much you’re business has spent. So, paying down loan balances does not affect your profit. Maintaining high profits does not mean your business is in the green. And businesses that are paying their bills on time may not actually be profitable.
- Cashflow only shows actual cash going in and out of your business. Overall profit goes much more in-depth, giving you an understanding of the income-generating elements of your business.
Get Ahead of Your Competition
Knowledge is power. And knowing how to best present yourself, and your knowledge of revenue and profitability, will allow you to move your business forward, especially in each of these instances:
Qualifying for small business loans and good interest rates means being able to show that your business is stable and both revenue and profit is increasing steadily; this is especially true if you’re planning on funding some new projects and ventures for your business, so you’ll want to make sure that you have the numbers to make creditors happy to help you.
It’s important to note that, in certain circumstances, you’ll need to show strong revenue numbers, not necessarily profit. In a lot of cases, investors will want to see that sales are consistent and growing. This is a great example of when not having high profits may not necessarily be considered detrimental. If sales have flat-lined, then growth has too. And that’s not what investors want to see.
Staying in the Game
Without money flowing in, your company won’t have enough money to stay in the game over the long run. Make sure your revenue streams are strong, and let your profit numbers show your hard work. Remember: low revenue never produces positive financial results.
When you know your numbers, you know what you can change to put yourself ahead. Whether it’s overhead, sales, or marketing. Knowing these numbers will give you the power to make informed decisions for the future of your business, and will keep you moving confidently in the right direction.
Running a successful business begins with understanding your finances. From revenue to profit to cashflow, knowing more makes you and your business more powerful. This can help prevent you from becoming a negative small business statistic, and can help you move forward, empowered by your financial knowledge. Have some thoughts or questions? Leave them in the comment section below.