Owning or operating a business might seem like a piece of cake, but without basic economic knowledge, you may experience a rude awakening. Being an educated businessperson means familiarizing yourself with all aspects of money management as well as staying abreast of current industry trends. Among the most pertinent pieces of information you should obtain when starting your venture are the definitions of revenue and cost and knowing their differences.
Businesses commonly generate revenue through the sale of goods or services; however, according to the Cornell University Law School, revenue can be earned through other means, such as interest, dividend or royalty payments. Interest payments create revenue by charging the patron a fee based on a percentage of the total amount owed. Dividends, which are deducted from the business’s total profits, are monetary payments made to business shareholders. Businesses or individuals receive royalty payments each time their product is used or sold. For example, an author receives a royalty payment for each book sold.
A profitable business generates three kinds of revenue: total revenue, marginal revenue and average revenue. Total revenue refers to the total amount of all sales and is configured by multiplying the price of a good or service by the total number of units sold. Marginal revenue equals the revenue gained by increasing the sales rate by one unit during a specific time period, which is calculated by adding the revenue of a one-unit sale to the total revenue and dividing that figure by the total number of units sold. Average revenue equals the revenue earned through the sale of each individual unit and is determined by dividing the total revenue by the total number of units sold.
Clyde P. Stickney’s book, "Financial Accounting: An Introduction to Concepts, Methods and Uses," defines costs as monetary disbursements provided to various individuals and companies for products and services rendered. In bookkeeping, costs are not assets, meaning they do not prolong or increase the value of a product or business. For example, a business vehicle is considered an asset; however, the fuel is a cost. There are many types of costs, such as implicit, explicit and total costs. Explicit cost refers to financial responsibilities incurred through the acquisition of products or services required to run the business. Implicit costs arise when a business uses its own products instead of purchasing items or services from another entity. Total cost refers to all costs, implicit and explicit, incurred by the business for normal operation.
When learning how to successfully own or operate a business, you will discover that there are three types of profits, accounting, normal and economic. Accounting profits are calculated by subtracting explicit costs from total costs. Normal profits equal the amount of revenue the business owner requires to sustain normal business operations. Economic profits, known as pure profits, equate to the total revenue minus all implicit and explicit costs. In accounting practices, the term “net income” refers to total revenues minus total costs, which equals the overall profit.
- Economics Concepts: Types/Kinds of Revenue
- Cornell University Law School: Personal Holding Company Income
- Financial Accounting: An Introduction to Concepts, Methods and Uses; Clyde P. Stickney
- The Red Carpet Broadcast: Types of Business Costs
- Economics Concepts: Difference Between Accounting Profit and Economic Profit
- Comstock/Comstock/Getty Images