In business, it’s all about the numbers. Maybe it’s the number of items your company sold last year compared to this year. Or the number of new clients you brought in. Or how many new followers your blog generated. These metrics are good and important to keep track of, but they’re missing something.
How do you know which data accurately reflects the financial health of your business?
One way of finding out how successful your business is doing on a broad level is by comparing the company’s revenue and profits from previous years. Although these terms may seem to belong to accountants and bookkeepers, understanding the difference is crucial to know where your business is headed. Let’s take a look at the difference between revenue and profit, and why that difference matters.
Simply put, revenue is the total amount of income a business generates in a given period, prior to subtracting any deductions. Taking all of the business’s sales from the year would calculate its annual revenue.
To be more precise, revenue is the total amount of money generated from the sale of goods or services – only from typical business operations. Interest in a bank account, for example, would not count toward a company’s revenue.
It is also important to note that there are two kinds of revenue: gross revenue and net revenue (or net sales). Gross revenue is the total sales a company processes in a given period, whereas net revenue takes into account the cost to process those sales. This usually includes discounts on items, returns, and allowances.
Here’s a quick formula for calculating net revenue:
Gross Revenue (Net Sales) - Cost of Sales = Net Revenue
Though revenue on its own cannot measure the financial health of a business, it is an extremely useful metric to track. For one, it can help you track the growth of your business. If your net revenue has increased from the prior year, it could be due to higher production of goods – or less cost to produce them. It can also help you track how well you are doing compared to competitors. To help you understand the sales your business is making, try asking these questions when calculating your revenue:
Revenue is not the whole story. Profit (also known as net income) is a term that denotes the number of funds left over in a business after all expenses have been paid. Profit can also be called the ‘bottom line’ as that is the number left over at the bottom of a balance sheet. It’s crucial to recognize that this number does not have to be a positive integer. Negative profits are a sure sign that something in a business needs to change – and fast.
While some would argue that revenue is the key indicator of a business’s success, profits are just as important. After all, you likely wouldn’t invest in a company that is losing money year after year, so why would you run one?
Here’s a simple formula for calculating your profit from your revenue.
Gross Revenue - Sales Costs - Operating Expenses = Earnings Before Interest & Taxes (EBIT)
Once you have calculated your Earnings Before Interest and Taxes, simply subtract the amount of interest accumulated. This will give you your Taxable Income amount. Simply calculate your taxes and subtract them from this number to get your net income/profit. Here’s the full breakdown starting from net revenue:
Net Revenue - Operating Expenses - Interest - Taxes = Profit
Keep in mind that though it may be tempting to just focus on the end profits, the money you get to retain for yourself, every line in the formula is worth paying attention to. Here are some questions you should be asking when you are calculating your annual profits:
To reiterate: revenue is the amount gained solely from sales of your business’s goods/services, whereas profit also takes into account all business expenses and taxes. Both are key performance indicators for the health of a business that shouldn’t be interpreted in isolation. Being a successful entrepreneur means knowing your business inside and out. Understanding revenue and profit in your business is a key step to achieving your financial goals.