Revenue Maximization Vs. Profit Maximization
Every business faces the decision of how to maximize profit. While revenue maximization and profit maximization may appear to be one and the same, this is not necessarily the case. Higher revenue does not always translate into higher profit because of how a small business executes its business and marketing strategy. A small business owner must decide the optimal business strategy that maximizes revenue and profit.
No matter the size of a business, revenue is important because it is the source of the business' income stream. Businesses take different approaches to maximize revenue using various marketing strategies as translated through their business model. A company can seek to grow revenue by offering the lowest prices in the market. Other companies focus on offering better products and services to differentiate themselves from the competition in hopes of maximizing revenue. In addition, companies also attempt various pricing strategies to capture different consumer groups, such as high-income, middle-income and low income households, in an effort to maximize revenues.
All else being equal, a strategy to maximize revenue should lead to maximum profit. To calculate profit, a business must subtract all of its operating expenses from its revenue. The level of these expenses varies from business to business. A business with high revenue may produce lower profit because of high operating expenses. On the other side of the spectrum, a company with low revenue may produce higher profits through cost cutting and focusing on keeping low overhead.
The goal for a small business owner is to find the optimal strategy that maximizes revenue and profit without having to sacrifice productivity and performance. Operating efficiency refers to how a company manages to generate revenue and control costs. Gross profit margin, is one of several operating efficiency ratios, calculated by subtracting cost of goods sold from revenue and dividing the result by sales. Cost of goods sold is the expense of raw materials used to convert them into items for sale. For example, if a company has sales of $1.2 million and had cost of goods sold of $600,000, its gross profit margin is 50 percent. In other words, the company keeps $0.50 for every $1 of revenue.
Another operating efficiency ratio, profit margin, shows how much money the company keeps for itself after taking into account all costs, which not only include cost of goods sold, but also rent, depreciation, utilities and other day-to-day costs of running the business. The formula for profit margin is net income divided by revenue. If the same company generated net income of $350,000, its profit margin is 29 percent, or $350,000 divided by $1.2 million. This means that for every $1 of revenue, the company retains $0.29 for itself. Profit margin allows the company to track profitability trends.