When a business earns revenue from selling its products or services to customers, that doesn’t mean it earns a profit. Revenue is what customers pay a company and is relatively easy to calculate. On the other hand, profit comes in three different forms and is what a business earns after it has paid for certain types of expenses.
Both revenue and profit are important to monitor and manage as they provide different facts about your business and its performance. Many refer to revenue as the “top line” and net profit as the “bottom line.” As you’ll see, this terminology corresponds to where revenue and net profit reside in an income statement.
Understanding the Top Line
A company’s income statement captures a business's performance over a week, month, quarter, or year. It includes what the company earns via sales and the indirect and direct costs it incurred to support the business.
When business people refer to the “top line,” they are talking about revenue, the first line item in an income statement. Growing the top line means increasing revenue.
Maintaining or growing your company’s total revenue is critical to long-term financial performance and stability. By increasing revenue, companies increase their ability to earn a profit. An aggressive marketing campaign, innovative pricing strategies, and entry into new markets can boost revenue. Yet, pursuing top-line growth is just one side of the financial equation.
Analyzing Profit from Different Perspectives
Adding dollars to revenue will only increase profits if the costs remain below revenue. Therefore, how companies manage their costs determines whether a business will earn a profit or generate a loss. So, in addition to monitoring revenue, business owners should also pay close attention to their costs and their impact on profits.
There are three ways to measure profits: gross profit, operating profit, and net profit. Gross profit is the revenue from sales less the cost of goods sold. Operating profit is calculated by subtracting operating expenses from gross profit. Net profit is what the company keeps after all its expenses, including operating costs, interest, taxes, and other non-operating expenses, are subtracted from total revenue. Since net profit is the last line item in an income statement, many refer to it as the bottom line.
Since net profit accounts for all forms of expense, it is the financial measure that investors, banks, and other stakeholders often focus on. However, gross and operating profits are just as important to monitor as they provide insights into different aspects of the business.
Financial statement users calculate gross, operating, and net profit margins to identify trends and facilitate comparisons between similar businesses. This involves calculating gross, operating, and net profit, dividing them by total revenue, and then converting them into percentages.
Revenue and Profit: Both Tell a Story
Revenue and profit each indicate a company’s financial health and operational performance. While revenue indicates the demand for a company’s products and services, net profit offers deeper insight into how the business manages its indirect and direct expenses.
Gross and operating profit are also important metrics as they can highlight changes and trends in fixed, variable, direct, and indirect costs that impact your company’s profitability.
Together, revenue and net profit provide stakeholders with the data to make informed decisions about a company’s financial health, competitive positioning, and overall financial performance.
