Understanding the difference between sales and profit is essential to understanding basic and complicated economics. Even if you don’t know exactly what these terms mean, you’ve heard the words casually.
Profit is money in your pocket and turnover is turnover, right? While that is sometimes true, more detail will help you clarify the difference and see how important it is to your future business endeavors.
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What is turnover?
Revenue is the total amount of money generated from business sales or other activities within the company. This is the total amount before any fees are taken into account or deducted from those sales.
You can calculate sales using this simple equation:
Price x quantity = turnover
Related: What is turnover? Here’s everything you need to know and how to calculate it
Annual Recurring Revenue (ARR)
A critical source of income vital to understanding is annual recurring revenue (ARR). ARR is turnover: specifically the expected annual turnover of customers.
This is usually determined by subscription agreements or recurring revenue streams. ARR is most common among companies with subscriptions for that specific reason.
Understanding ARR is critical because it provides businesses with a predictable revenue stream.
This helps predict cash flow and plan for future growth or changes in the business. ARR is also an excellent indicator of predicted return on investment (ROI) for investors.
Related: Return on investment (ROI)
What is Profit?
Profit is the total profit or loss of money a company has. The simple equation to achieve this number is:
Income – expenses = profit
Profit is calculated by subtracting total expenses from total revenue. These expenses can be generated by business activities, such as utilities or employee payments, or by the amount generated from taxes or other technicalities.
Related: What is turnover? Here’s everything you need to know and how to calculate it
Gross Profit
Gross profit is a profit category that is important to know as an businessroundups.org. You can calculate gross profit with this equation:
Revenue – the cost of goods sold (COGS) = gross profit
Because COGS includes the cost of producing and delivering a product or service, gross profit measures a company’s profitability before deducting operating expenses.
This helps the company by breaking down the steps to finding net profit, which can reveal points of weak profitability in a company’s production and taxation.
Operating profit
Operating profit is the next step in the net profit calculation. It is similar to gross profit but includes three more expense categories. You can calculate operating profit with this formula:
Revenue – COGS – Operating Expenses – Depreciation – Amortization = Operating Profit
Depreciation and amortization are two more ideas that you need to understand as a business owner. Depreciation reduces the true value of equipment or vehicles due to time or use.
This calculation gives a numerical value to the cost of the asset versus its operating and salvage value.
Amortization refers to the value of intangible products such as patents or trademarks. It is calculated in the same way as depreciation.
Both methods help spread the cost of assets over their useful lives and provide a more accurate picture of a company’s expenses and profits.
Net profit
Net profit is the final calculation that determines a company’s actual profit. You can calculate net profit using this equation:
Gross Profit – Operating Expenses – Taxes
If you missed it, just subtract all expenses from income. This net profit indicates a company’s overall profitability and is usually an attractive number to investors if it is large enough on your financial statement.
Related: 4 ways net profit margin equals happiness in life
What are the critical differences between sales and profit?
So if we compare the definitions above, revenue is simply a company’s total revenue, while profit uses that number to calculate actual profitability. They are calculated in different ways and used differently.
Revenue calculates sales and market share growthwhile profit is more important for profitability and financial health.
Another essential thing to note is the typical fluctuation of these numbers. Revenue is often highly volatile as it depends on market demand and other factors, while earnings tend to be more stable over time.
Where do you find sales and profit on an income statement?
Income is usually reported as the first item on the income statement. This is known as the top line. Based on the period of the financial statement, it only shows the total revenue from that period.
Profit is reported last on the income statement, known as the bottom line. Net profit is on the bottom line of the types of profit discussed.
Related: What exactly does your income statement tell you?
Why is it important to understand the difference between sales and profit?
Fortunately, these things are not specific to the corporate and entrepreneurial world. Anyone with the right knowledge and preparation can generate income and in turn reap their financial gain. Here are just a few ways to do this.
One idea you need to understand about profit in particular is short-term and long-term profitability. A good example is investing in a very small APY, even 2% or 3%.
A company can prioritize short-term profitability by cutting costs and reducing investments, leading to higher short-term profits.
However, this may not be sustainable in the long run as it could harm the company’s growth and future profitability.
A company can prioritize long-term profitability by investing in research and development, expanding operations, and improving the customer experience, even if it means lower profits in the short term.
Related: How to Value a Business: 9 Ways to Calculate the Value of a Business
An example of sales versus profit
For those who learn better from examples, consider the following example to help you differentiate between revenue and profit.
A company sells t-shirts for $10 each. Last month they sold 100 t-shirts. The yield is therefore calculated as follows:
$10 (price) x 100 (quantity) = $1000 (sales)
So for the past month, the total proceeds were $1000. But not all $1000 can go directly into the owner’s hand.
Consider the costs of the business. It costs the company money to make the t-shirt, rent the shop, and pay the employees and utilities for building the operations. These are just some common examples; every business has multiple expense categories.
So if we add all those things together:
$1000 (revenue) – $750 (cost) = $250 (gain)
What remains of the equation is your net profit. If you want to go into more detail, you can separate each type of expense from the calculation of each type of profit. But in summary, the revenue in this example is $1000 and the net profit is $250.
Frequently asked questions about sales and profit
Despite clear explanations and definitions, many questions still arise when discussing these two principles.
1. Can you have a higher profit than turnover?
No. This is a simple math question. Since profit is calculated by subtracting expenses from revenue, you can never have a higher profit than revenue. In mathematical terms, you should have a negative amount of expenses, which would be no expenses.
2. How does revenue differ from revenue?
While revenue and sales are usually interchangeable and usually identical, there is a distinction that is important to keep in mind.
sale are a subset of revenue. As discussed, revenue is the total money a company earns over a period of time. Sales is the amount of money a company makes from selling products or services. It only refers to the funds generated from the sale of goods or services.
3. Which is more important: turnover or profit?
This question all depends on your situation. If you have these two metrics and need to use them, you need to understand your problem statement before attempting to make those calculations.
For revenue, you can understand how your business generates revenue from your core business. A high turnover generally means that the company is selling more, which is a positive sign for any company. However, this does not indicate financial health as expenses are not taken into account.
With regard to profit, this should be your indicator of financial health. Profit is the number that shows returns to investors or shareholders, who are critical parts of your business.
So profit is more important for understanding the growth and livelihood of the company as it indicates that the operations, investments and shareholder ROI can be maintained.
Related: Understand profit, cash flow and ROI to ensure the financial health of your business
What insight into turnover and profit can mean for your company?
It is vital to address the ethical considerations of monetization and profit generation. Businesses should strive to generate revenues and profits that benefit all stakeholders.
Generating short-term profits that exploit stakeholders or harm the environment can have long-term negative consequences for the company and the economy as a whole.
Therefore, companies should strive to balance revenue generation and profit with social and environmental responsibility.
For those with significant monetary value, comes a level of responsibility with that wealth. Always do your best to manage your assets in an ethical manner.
Checking out Other businessroundups.org Articles for more information on revenue, profit and other financial topics.
