There's more than one way a business can earn money. One way is by selling services or products, which is usually what the business was created to do. Money made this way is classed as revenue profit. Companies can also make a profit when they sell stock or sell off assets, which is called capital profit. It's important to keep the two separate in your business accounting.
Revenue profits are what your company makes by going about its business. It doesn't matter whether the business is selling diapers, mowing lawns, selling diesel fuel or running a nursing home. The profits you earn from your operations are revenue profits. To measure them accurately, you'll have to subtract the expenses involved in making money from the total revenues. Say you sell $3,600 worth of over the counter medicines that cost you $3,100 to order from your suppliers. Your revenue profit on the sale is $500.
Capital profits bring money into the company two different ways.
- You sell bonds or issue stock to raise money from investors.
- You sell off one of your fixed assets, such as a car, a building or a smelter.
The profit on the sale of an asset is the sale price minus the value recorded in your ledgers. Selling an asset valued at $2,000 for $2,400 gives your company $400 in capital profit. For stocks or bonds, the measure is the sale price over the "par" or face value of the issue.
These profits are different from revenue profits. A healthy company generates revenue profit on a regular basis; the transactions that create capital profits only happen occasionally and irregularly.
Revenue and Capital Losses
There's no guarantee a sale will work the way you want it. If you suffer a loss in your everyday operations, such as selling goods at a steep discount just to get them out of your store, you report that in your ledgers as a revenue loss. A capital loss is what happens if you sell off fixed assets for less than the value you set on them.
Recording the Income
When you prepare your company's income statement, you include both capital profit and revenue profit for the period. You do not, however, lump them together. Revenue profits fall under the category of operating revenues, income earned from the company's business. Capital profits go down in a separate category, called gains. Losses are separated out the same way.
This helps people reading the income statement get an accurate picture of your company's financial health. If you sell off a factory, that may bring in a lot of income. If you lump it in with sales revenue, it will make your operations look much more profitable than they really are. Conversely, a loss from selling an asset makes your company look weaker than it is. Separating the different income types gives readers a clearer picture.
Fraser Sherman has written about every aspect of business: how to start one, how to keep one in the black, the best business structure, the details of financial statements. He's also run a couple of small businesses of his own. He lives in Durham NC with his awesome wife and two wonderful dogs. His website is frasersherman.com