When words seem so similar, sometimes using the wrong one lands you in hot water. In business, there's a lot tied to getting the lingo right, and that’s why it’s important to understand the difference between revenue and profit because many people tend to think they’re interchangeable, but they're not.
Revenue vs. Profit
When speaking about cash and your company, it’s important to distinguish between revenue and profit. In simplest terms, "revenue" is the total amount of money flowing into your company from the sales of goods and services. "Profit" is the figure left over after business costs, debts and any other money outflow have been deducted.
But it gets a bit more complicated because there are different kinds of revenue and profit.
Types of Revenue
When speaking about revenue, all the money received from goods and services sold, this is a company’s “top line,” a colloquial name earned because this sum is listed at the top of the income statement before any expenses are figured in.
“Accrued revenue,” though, is unrealized revenue or money that has not yet come in, despite having been invoiced. This is common for companies that invoice on a net-15 or net-30 basis, or through other payment terms.
In these instances, when the sale or service is invoiced, it’s noted as a revenue source or sale in the income statement, and on the balance sheet, it’s marked down as an accrued revenue asset. Say it’s a sale of $100 in question. When the $100 comes in, the income statement’s cash account balance goes up by $100, the accrued revenue account drops by $100, but the overall income statement still reflects a gain of $100 in revenue for when the transaction originally occurred, as opposed to when the $100 was received.
On the other hand, there’s also “unearned revenue.” This is a common distinction for when companies require deposits against goods or services. If, for instance, it’s a minor renovation job, like house painting, that requires a $1,000 deposit against the work for purchasing supplies, then that’s $1,000 in unearned revenue. This money is typically not noted on the income statement until the goods or services are delivered and invoiced in full.
Types of Profit
“Net profit” is when all expenses, debts and costs are deducted. The money that’s in the free and clear is the net profit, also called “net income.” This is also called the company’s “bottom line.”
“Gross profit” is the amount left over when the costs of goods sold are deducted from the revenue. These costs include any labor or materials used in the production of goods or performance of services.
Then there’s “operating profit,” which begins with the gross profit sum, then has any operational costs deducted, which includes categories like utilities, rent and payroll. What's left over is the operating profit.
Disparities Between Revenue and Sales
When it comes to thinking about revenue, the tricky thing is that sales and revenue are often considered the same thing, but sales can exceed revenue, and vice versa.
Perhaps a company operates in retail, selling goods. Returned merchandise becomes a refund, so despite selling $487,000 of goods before Christmas, say they’ve had $54,000 returns in the first couple of weeks after the holidays. This means they have $433,000 in revenue despite $487,000 in sales. This large amount of returns affects the revenue amount but also counts against the profit, too.
Then again, revenue can be much higher than sales, due to non-operating revenue, which can generally be one-time monetary gains or events. These can include property or asset sales, litigation awards, investments paying out, incoming donations, royalties and other fees received. Non-operating revenue is cash coming in, but not tied to sales in any way. So say an agricultural company sells two of its long-used tractors for a total of $89,000 during a month with $39,000 in sales of their agricultural goods. Their revenue will be $128,000, yet sales comprise just $39,000 of this amount. Still, the total revenue of $128,000 is applied toward the profit.
Cash Flow vs. Revenue
Sometimes, companies and even self-employed entrepreneurs make the fatal mistake of equating sales revenue with cash flow. This is the “counting your chickens before they hatch” cautionary tale.
Perhaps a self-employed graphic designer lands a large new client – a magazine. With dollar signs in his eyes, he shuns other business to focus on this lucrative contract for the month, because it pays a substantial sum and he can invoice at month’s end. His terms are net-15 and he presumes his cash will be in-hand within six weeks.
However, just because he has the sales and his month is, in theory, a very profitable one, it does not mean the magazine gives one hoot what his payment terms are. They have a system, and somewhere in the fine print of the contract, it says payments aren't released until 30 days after the magazine is mocked-up and approved by the editor-in-chief. The designer learns this too late and receives his cash six months down the line, forcing him to scramble in the meantime. Because, despite his lucrative month, the landlord doesn’t get paid in promising invoices and it doesn’t keep the lights and heat on, either. And this is true for any business – your accounts payable don't care what you have coming in; they want their money when it's due.
Cash flow, then, is when money comes in or money goes out, and revenues posted have little to do with when those monies move around. Depending on your cash before it’s in-hand leads to companies over-committing themselves financially because money doesn’t arrive on their preferred schedule. And then there’s the reality that not all bills get paid, and some clients or jobs may simply be deadbeats, or they may run into their own bad luck and have to declare bankruptcy, making your invoice one you'll never collect on.
Why Is Revenue Important?
A day doesn’t go by without some corporation's share price being reported as rising or falling, based on reported revenues versus expected revenues. Billions are gained and lost annually on Wall Street, thanks to revenue targets.
Operating costs are important and cash flow is critical, but in the eyes of stock-watchers, there is arguably no greater benchmark for how a company is doing than its revenues.
Stockholders often watch revenue reports with bated breath. It’s these reports which reveal whether a company has met its targets. Meeting targets is about achieving objectives, delivering results and making good on potential. Not meeting them, on the other hand, can be akin to the canary in the coal mine, a signal of a downturn – perhaps the CEO’s vision is wrong, maybe the economy is generating cold feet and orders are beginning to decline. Maybe the company misjudged the appeal of their latest releases.
For some industries, like retail, where items are bought and sold with short time frames, these revenues and expectations benchmarks are easier to interpret. But, in others, like real estate, film and television or other entertainment, health care and tech, it’s much harder to interpret revenue versus profit and cash flow, because projects can be in development for so long before money changes hands.
For instance, filmmaker James Cameron has been spearheading the second, third, fourth and fifth installments to the global blockbuster "Avatar," released in 2009, for years already. They’re creating all-new technology to film the movies so audiences can watch in “glasses-free 3D.” So, for a few years, this means massive operating costs the producers have had to assume and will continue to assume until the films are all released between 2020 and 2025. Then, they hope, they’ll benefit not only from four hopefully record-smashing releases, but proprietary ownership of technology that will change filmed entertainment forever.
Ultimately, companies cannot ignore cash flow, operational costs or profit – they’re as critical to success as revenues are. While investors, banks and Wall Street watch for revenues, companies need to keep themselves grounded and focus on all the aspects of money generation and cash flow if they are to weather the business storm for the long run.