Running any business may seem easy from the top above. However, any business includes a lot of metrics that need to be studied. When you go to any official financial report of a business, you can find many financial numbers in it. You will see gross profit, revenue, profitability, net sales, expenses, and whatnot. Two metrics that define the overall health of any business are revenue and profitability. These metrics may sound easy to understand but can cause a lot o confusion for many.
Revenue vs profitability is something many people overlook. However, it is the most important aspect for any company. Whether you are a big MNC or a startup, these two metrics will define your growth and future.
Let us understand both the terms and what is the difference between them!
What is Revenue In Business?
Revenue is the total money generated by the business. A business can generate this revenue from its operations. The operations can include sales or a particular product or a service that the business provides. Apart from operations, a business can also generate revenue from taxes, real estate, investments, fees, and other routes.
Revenue does not include any kind of expense that the company has to pay. It is the money without deducting any expenditure for the company. Revenue is often called the “top line” in financial slang.
Revenue as a metric does not depict how a business is performing as it does not include the profit margins. It is simply the total money generated. However, it can help you understand where you stand in terms of your company’s growth. This metric alone is not sufficient to determine the financial health of any company. But, combined with profitability and other metrics, this metric helps a lot.
In a nutshell: Revenue is the total money your business generates from its primary operations.
What Is Profitability In A Business?
Now comes the question of profitability. Profitability is the money your business generates after all the expenses are deducted. This is the money which is your profit and you get to take this back home. Profit is what your business has achieved as a means of its operations. A company may generate a lot of revenue. However, it may also have a huge expenditure resulting in no profit.
In a simple formula, we can say that
- Profit = Total Revenue – Expenses
Expenses may include your investments, transport costs, customer support costs, employee salaries, and much more. So, profit is the money your business has actually earned. It is not the revenue but the profit. Profit is often called the “bottom line” in financial slang.
Profitability is one of the most important metrics that help you determine the actual financial health of your business. A business is of no use if you are not making any profits! No business is good that is generating a business of $1 million and then spending $1 million as well. Profitability is what drives a company’s future.
In a nutshell: Profitability is the money your business is left with after you make all the expenses. This is the money you get to take back home as your earnings.
Revenue VS Profitability: Understand With An Example
Let us understand the difference between revenue and profitability with an example. Assuming you are a business owner. You sell headphones.
You completed 100 headphone orders in January 2023.
You sell each headphone for $5 per unit.
- Total Sales = Number of Headphones X Cost Of Each Headphone
- Total Sales = 100 X $5
- Total Sales = $500
The amount of $500 is your revenue. This is the total sales you did in January.
Now, let’s say you invested $0.1 for transporting each headphone to your clients. Another $100 for the salaries of your employees. And the raw material used to manufacture a single headphone was $0.2. So, total expenses are
- Transportation Cost: Number of Headphones X Cost Of Transporting
- Transportation Cost: 500 X $0.1
- Transportation Cost: $50
- Manufacturing Cost: Number Of Headphones X Manufacturing Cost Per Unit
- Manufacturing Cost: 500 X $0.2
- Manufacturing Cost: $100
- Employee Salaries: $100
- Total Expenses: Transportation Cost + Manufacturing Cost + Employee Salaries
- Total Expenses: $50 + $100 + $100
- Total Expenses: $250
- Profit: Total Revenue – Total Expenses
- Profit: $500 – $250
- Profit: $250
Hence, the profit for your business would be $250 and not $500 (revenue)
Bottom Line
If you observe, the revenue is $500. The number looks good. However, it is not what you would take back home as your earnings. The actual amount is $250 as your earnings. This is what your real business earnings are.
Looking at the total revenue may give you a clear picture of your sales and marketing efforts. However, deducting the expenses and looking at the profitability is the real metric you would want to increase.
Most companies focus on increasing revenue and decreasing expenses. This would automatically help you increase your profits. When it comes to evaluating a business, it’s important to understand the difference between revenue and profitability. Revenue is the total amount of money that a business brings in and profitability refers to how much of that revenue is kept after taking into account operating costs and other expenses.