As a business owner, understanding the difference between revenue and profit is essential to running a successful business. While these terms are often used interchangeably, they refer to different aspects of your company’s financial performance.
Revenue is the total amount of money your business generates from sales or services. It’s the top line of your financial statement and represents the total amount of money your business brings in before deducting any expenses.
Profit, on the other hand, refers to the amount of money your business makes after deducting ALL expenses from revenue. It’s the bottom line of your financial statement and represents your business’s actual earnings or net income.
To illustrate the difference between revenue and profit, let’s consider an example. Let’s say you run a bakery and sell 1,000 cupcakes for $2 each. Your revenue from cupcake sales would be $2,000 (1,000 cupcakes x $2 per cupcake).
However, to make those cupcakes, you incur expenses such as ingredients, labor, and packaging. Let’s say those expenses total $1.50 per cupcake for a total of $1,500. Subtracting that amount from your revenue gives you a gross margin of $500.
In this example, you can see that while revenue is important for the success of your business, it’s not the whole story. Profit is what ultimately determines the success or failure of your business.
In addition to expenses directly related to the production or sale of your product or service, your business may also have overhead expenses, such as rent, utilities, and administrative costs. These expenses are necessary to keep your business running, but they don’t contribute directly to the production or sale of your product or service.
Overhead expenses can have a significant impact on your profit, as they reduce the amount of money that’s left over after deducting expenses from revenue. For example, if your bakery had $450 in overhead expenses in addition to the $1,500 in expenses related to cupcake production, your profit would be reduced to $50 – or even lower if your overhead expenses were higher. This is your profit, aka net income.
Let’s compare these numbers to a few of your competitors:
| You | Competitor A | Competitor B | Competitor C | |
| Units Sold | 1,000 | 1,000 | 1,200 | 800 |
| Price Per | $2.00 | $2.25 | $2.00 | $1.85 |
| Revenue (Units x Price) | $2,000 | $2,250 | $2,400 | $1,480 |
| Cost Per | $1.50 | $1.75 | $1.75 | $1.25 |
| Variable Expense (Units x Cost) | $1,500 | $1,750 | $2,100 | $1,000 |
| Gross Margin (Revenue – Expense) | $500 | $500 | $300 | $480 |
| Overhead | $450 | $450 | $450 | $400 |
| Profit / Net Income (Gross Margin – Overhead) | $50 | $50 | -$150 | $80 |
At first glance, you may be tempted to draw some inaccurate conclusions about how your business stacks up to your competitors. For example, looking only at revenue, you may conclude that your business is not doing as well as Competitor A or Competitor B. You may also conclude your business is stronger than Competitor C. Competitor A, however, only has higher revenue due to a higher price point (they sold the same number of units) and that additional $0.25 of price seems to be a reflection of a similar $0.25 increase in variable expense which leads to the same gross margin and, ultimately, the same profit. Competitor B sold more units and generated higher revenue but, due to increased costs, actually lost money.
After careful consideration, Competitor C begins to look like the strongest competitor. While both their units sold and total revenue are lower, the combination of lower variable costs and lower overhead resulted in 60% MORE profit ($50 x 160% = $80). Not only did they manage to generate more profit, but they also did it by making fewer cupcakes which means less effort.
To improve your profitability, it’s important to track not only your revenue and expenses related to product or service production but also your overhead expenses. Look for ways to reduce your overhead expenses without compromising the quality of your product or service. For example, you could negotiate a lower rent or utility rate, switch to energy-efficient equipment, or outsource certain administrative tasks to save on labor costs.
By carefully tracking and managing both your revenue and expenses, including overhead, you can improve your profit margin and build a more financially stable and successful business.
