When reporting or looking at a profit & loss (income) statement, the main figure that bosses and investors are interested in is net profit, aka the bottom line.
Beginners to the world of accounting, especially those who are just starting a business, may confuse revenue with net profit, it’s easy to see why.
Knowing and understanding the difference is actually relatively simple.
We’re going to break down revenue and net profit separately. Then, we’ll compare and draw the differences between them.
Below is an illustration of where you’ll find each of these on the income statement.
You might have noticed those elements below operating profit. These are further losses or gains that will come off or add to your operating profit to make your net profit. We won’t be discussing these here, as we’re just going to focus on the basics to keep things simple.
What is revenue?
Revenue, aka the top line. Called so as it sits at the top of the income statement.
This is the total amount of money that a business has made before all expenses.
This is the easiest element of the profit and loss to understand in my opinion. You just take the total amount of money you make from any sales before deductions. Here’s an example:
Say you run a shoe shop, you sell 200 pairs of shoes one month at £45 each. Your revenue is as follows:
200 x £45 = £9000
That is your total revenue for the entire month.
Keep this example in your mind as we’ll be referring to it in the next section.
What is net profit?
Net profit, aka the bottom line. Called so as it sits at the bottom of the income statement.
This is the total amount of money that a business makes after all expenses.
When we say “expenses” we mean anything that a business needs to pay for before it can make any money.
These are often referred to as fixed or variable expenses.
A business is likely to have any number of these.
Fixed costs (aka indirect) are costs that remain the same each month.
Variable costs (aka direct) are costs that can change each month, often depending on how well the business is doing.
Let’s return to our shoe shop and take a look at some examples of fixed and variable costs this business might encounter:
- Fixed (Indirect) costs
- Rent & lease payments
- Employee salaries (if salaried)
- Variable (Direct) costs
- Number of shoes ordered in as stock
- Credit card fees (dependent on the amount of credit card transactions)
So, let’s create some costs for our business:
- Fixed costs
- Rent & lease payments = £300pcm
- Employee salaries (if salaried) = £1400pcm
- Insurance = £50pcm
- Utilities = £320pcm
Our fixed costs give us a total of £2070pcm
- Variable costs
- Number of shoes ordered in as stock (aka cost of goods sold) = 200 pairs @ £20 = £4000
- Hourly wage employees = 1 part-time helper = £600
- Credit card fees (dependent on the amount of credit card transactions) = 2% on each credit card transaction = £175
Our variable costs come to a total of £4775 for this month. Remember variable costs can change from month to month.
We now add our fixed and variable costs together to give us our total costs for the month: £6845.
If you remember, we sold 200 pairs of shoes this month at £45 a pair. This totalled £9000.
This is our revenue, as revenue is any money the business makes before expenses.
Our total costs for the month were £6845
Net profit is any money the business makes after fixed and variable expenses.
In order to get our profit for the shoe shop, we need to take our costs from our revenue.
6845 (total costs)
The image below shows how all this might look on the profit and loss statement.
Now we have our net profit, we can take a look at the differences between it and revenue.
Net Profit vs Revenue: What’s the difference?
You should now have a pretty good understanding as to what profit and revenue are, along with fixed and variable costs.
If you only remember one of the differences I’m about to mention, let it be this one.
The key difference between profit and revenue is that net profit is the amount of money a business makes after every operating expense has been deducted. Revenue is the total amount of money a business makes before any expenses have been deducted.
Net profit cannot exist without revenue, it depends on it. In fact, net profit is a part of revenue, it’s just what is left at the end after you’ve taken away all the costs.
Unfortunately, net profit doesn’t always exist, if the sum of costs is greater than the revenue earned, then a business will be making a loss.
What does revenue say about my business?
Revenue is a good indicator of total sales growth.
This is because your revenue comes from sales alone and will show sales growth without your costs taken off (which is what profit shows), which may also be increasing as you’re investing in expanding the business.
You might be wondering, “isn’t net profit as good or better at telling me sales growth, surely if my profit is increasing my sales are increasing too?” Well as we know net profit does give an indication of success, but your can costs increase at the same time as your sales increase. Therefore it’s hard to tell how much better your sales are getting when your costs are increasing.
What does profit say about my business?
Net profit gives a more complete picture of the business than revenue.
You can have revenue from sales but profit will only exist after expenses are taken off. This means that the business is making enough to cover its expenses and leave money at the end.
Net profit is usually seen as an indicator of when a business is healthy. It allows a business to expand and invest more in itself – you might be able to give yourself a pay rise too!
So we know:
- Revenue: The money the business makes before any expenses are taken off.
- Net profit: The money the business makes after any expenses are taken off.
The expenses can be made up of two different types of cost:
- Fixed costs: Costs that stay the same every month, for example, rent or utilities.
- Variable costs: Costs that can change each month, for example, stock orders or raw materials.
With this knowledge, we can draw differences between the two. We mentioned 3 key differences:
- Net profit doesn’t always exist, whereas as long as a business is making sales, revenue does.
- Revenue doesn’t always mean a business is healthy. Net profit, on the other hand, is usually a good indicator of when a business is healthy.
- Remember, net profit cannot exist without revenue, it depends on it.
Join me for my next article in which we’ll look at Gross vs Net Profit and comparing the differences between those.