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Revenue vs. Profit: The Difference & Why It Matters

01/12/2022 | 07:16am EDT

Revenue and profit are two of the most prominent, crucial metrics every business needs to track if it wants to understand its performance, forecast effectively, and spend wisely - among a host of other key functions and activities.

Each term is distinct in its application and measurement, but despite those differences, the two concepts are often conflated. Here, we'll take a closer look at the difference between revenue and profit and see how to find one from the other.

What is the difference between profit and revenue?

Revenue is the total income a business generates through its sales. Profit is the portion of that income that remains after subtracting that company's operating costs, debts, taxes, and any other expenses it incurs in the interest of generating revenue.

You need to have a consistent picture of your business's revenue and profit if you want to reliably gauge its financial health and viability. Both metrics can be telling into the effectiveness of your sales and marketing efforts along with the efficiency of your spending.

It takes some steps to pare down your revenue figure to your profit. Let's take a look at how you can get from one to the other.

How to Get From Revenue to Profit Starting With Gross Sales

A company's gross sales is the most fundamental measure of the income it generates - without accounting for allowances, discounts, and returns. It's the product of the number of units of a product or service a business sells and the price those units are sold at.

In some respects, it could be considered a type of revenue - but it doesn't accurately reflect the income a business brings in and usually isn't listed on an income statement.

Getting from Gross Sales to Net Sales

Net sales is a much more practical reflection of a company's overall revenue. It accounts for all the sales a company makes but considers three key factors that impact the price a product or service might be sold for:

  • Allowances - Retroactive discounts a buyer receives after they discover and report some sort of defect with a product.
  • Discounts - Reductions in price a seller offers a buyer in exchange for immediate or early payment.
  • Returns - Partial or full refunds buyers receive for sending a product back to a buyer.

Once those elements have been folded into a company's financial reporting, that business has a clearer picture of its actual revenue. For more information on the difference between gross and net sales, check out this article.

Getting from Net Sales to Gross Profit

Once you've established your net sales, you can calculate your gross profit by subtracting the cost of goods sold (COGS) - the costs directly associated with the production of your product, including raw materials and labor - from your net sales figure.

Getting from Gross Profit to Earnings Before Interest and Taxes (EBIT)

After calculating your gross profit, you would whittle that figure down to earnings before interest and taxes (EBIT) (also known as operating profit) by subtracting your operating costs - the costs associated with the resources your business leans on to remain operational, including employee salaries, rent, legal fees, sales expenses, and marketing costs.

Getting from EBIT to Net Profit

As you can probably assume, you can find your net profit by subtracting the value of any interest or taxes you incur from your earnings before interest and taxes. That final figure is the most accurate reflection of your company's profitability over a given period.

Revenue vs. Profit Example Starting With Gross Sales

Let's say a manufacturer moved 5,000 orders of 1,000 units at $1 per unit in the past fiscal year. In that case, the company's gross sales would be $5,000,000.

Getting from Gross Sales to Net Sales

Now, let's imagine that of those 5,000 orders, 100 buyers reported defects and each received an allowance of $0.15 per unit. Another 100 received a discount of $.05 per unit for paying for their order in full upon their initial purchase. And another 100 returned their purchase for a $0.50 per unit refund. That would mean the company would have to account for:

  • $15,000 in allowances
  • $5,000 in discounts
  • $50,000 in returns

Taken together, those deductions would chip into the company's gross sales by $70,000 - leading to a net sales (or revenue) figure of $4,930,000.

Getting from Net Sales to Gross Profit

From there, the company would subtract its COGS from its net sales to get its gross profit. Let's say it takes $0.25 in raw materials and labor costs for the company to produce each individual tennis ball - so the COGS for the 5,000 shipments the manufacturer moved would amount to roughly $1,250,000. That would make the company's gross profit $3,680,000.

Getting from Gross Profit to Earnings Before Interest and Taxes (EBIT)

Once the manufacturer has its gross profit, it would find its earnings before EBIT by subtracting its operating costs. Let's say the company spends $2,500,000 annually on employees' salaries, $200,000 annually on rent for its facilities, $100,000 on its marketing efforts, $15,000 in accounting fees, and $10,000 on travel expenses for its salespeople.

Assuming that's all it takes to keep the business operational, its operating costs would be $2,825,000. That would make the company's EBIT $855,000.

Getting from EBIT to Net Profit

Once its earnings before interest and taxes have been established, the company would find its net profit by (you guessed it) subtracting the interest and taxes it pays. Let's say those fees amount to 35% of the company's income. That means the business would pay $299,250 in interest in taxes - making its net profit $555,750.

So as you can see, there's a pretty sizable gap between the company's revenue ($4,930,000) and its net profit ($555,750).

Every business needs to have a grip on the distinction between revenue and profit. The two metrics have different practical applications and varying implications for the health of your business.

Originally published Jan 12, 2022 7:00:00 AM, updated January 12 2022

Topics:

Accounting
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Disclaimer

HubSpot Inc. published this content on 12 January 2022 and is solely responsible for the information contained therein. Distributed by Public, unedited and unaltered, on 12 January 2022 12:15:05 UTC.


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Sales 2022 1 728 M - -
Net income 2022 -106 M - -
Net cash 2022 997 M - -
P/E ratio 2022 -142x
Yield 2022 -
Capitalization 14 996 M 14 996 M -
EV / Sales 2022 8,10x
EV / Sales 2023 6,22x
Nbr of Employees 6 404
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