What is the Relationship Between Revenue and Profit?
Sometimes people are confused about the relationship between revenue and profit. Revenue is the amount of money a company receives from sales and other charges to customers. Profit, however, is the amount of money left over from a company’s revenues after its expenses have been subtracted, such as supplies for creating a product, taxes, rent, marketing, and even payroll expenses. A company can have revenue without making a profit, but cannot have a profit without any revenue. In some cases, a company's expenses exceed its revenue, and it experiences a loss rather than earning a profit.
It is easy to think a company is making a profit if it is collecting fees and charges or selling products or services to customers. The fact that money is being passed from a customer to a business person, however, doesn't necessarily mean the business is profitable. In some cases, a company may have significant revenue but enjoy very little profit from its sales. This usually occurs because a company's expenses are so high that they make it hard for the company to earn a profit. Sometimes, however, revenues can be so low that even small expenses can eat away at the company's potential profits.
Considering an example may help to make the relationship between revenue and profit clearer. If, for example, a company specializes in selling customized lampshades, its expenses may include the costs of buying supplies and lampshades; wages; rent or a mortgage on a commercial property; taxes; advertising fees; utilities; and a wide range of other expenses. If this company sold $10,000 US Dollars (USD) in custom lampshades in a month, it may appear to earn a high amount of profit. Subtracting $8,000 USD in expenses from its sales would leave it with less of a profit, however. Its profit would be $2,000 USD in such a case.
Business owners typically strive to have both revenue and profit, but sometimes circumstances make it difficult to do so. In some cases, businesses don't sell enough to secure both revenue and profit. Often, this is not the business owner’s fault, but some entrepreneurs do make poor choices that leave them without much profit. Sometimes, a business owner’s expenses are so high that he experiences a loss; this means he not only failed to earn a profit, but he also lost money on running his business. For example, if a business owner’s revenues are $5,000 USD, but his expenses are $6,000 USD, he is losing money on running his business.
I have a friend who owns a bar/restaurant which is extremely popular. He struggled to make a living from it, despite being full most evenings. In the end his puzzled accountant did a little sleuthing and discovered the owner comping friends a little too often!
We joked for a long time that you could calculate his lost profit by the size of his friends' waistlines!
@Penzance356 - Many people who start a business will struggle to balance the profit and revenue books quite as they would like.
The only exception may be someone who works online or as a kind of virtual distributor. My sister does both and manages to keep her overheads and outlay quite low. Even so, if you look at revenue vs profit you'd probably be surprised at how little she comes out with.
She tells me that as you develop and grow the costs rise as advertising must be maintained. You may also need to pay for extra workers to meet demands, but not make quite enough to cover that expense for a while.
The difference between revenue and profit is something a new business owner needs to be very aware of.
I once read that it can take up to three years for a small company to get into the black. During this time the entrepreneur may not even pay themselves a salary, which would help keep revenue costs down.
Presuming that you are not paying out large salaries, is there any secret formula to increasing your profit ratio?
Post your comments