What is Revenue vs. Profit?
Two of the first financial metrics every investor wants to know about—and companies are apt to report—are revenue vs. profit. They are, after all, the two most important indicators of financial health. The more revenue a company sees, the more money it has coming through the door. The more money it keeps, the higher the profits it records.
Revenue vs. profit is an important comparison to make, but it’s not the only measure of these two variables in relation to each other. Investors need to recognize them for what they are, based on what they represent. Here’s a quick breakdown of revenue, profit and the stories they can tell about a company’s financial health and trajectory.
Defining Revenue and Profit
Before we dive into what they mean in relation to one another, it’s best to quickly recap what revenue and profit are by themselves. Here’s a refresher on their definitions.
- Revenue is the total income generated by a business, also known as sales or income.
- Profit is the remaining cash leftover after a business subtracts expenses from revenue.
It’s best to think about revenue vs. profit in terms of top-line and bottom-line figures. Revenue is a top-line figure because it represents the gross income of the company: its outright ability to generate cash. Meanwhile, profit is the bottom-line figure: the amount a company actually keeps after deducting the costs of doing business.
The Relationship Between Revenue and Profit
Revenue and profit are two sides of the same coin, and tell two stories of how a business operates. Revenue tells the tale of sales; profit tells a story about efficiency. Here’s a look at what they mean when combined, based on performance:
Low Revenue, Low Profit
Low figures on both sides represent a company that’s in dire straits. It’s not bringing in enough money (revenue) and the sales it is making are either at a loss or at a margin that’s not enough to sustain the company (profit). Companies in this position need a dire overhaul of business model and strategy.
High Revenue, Low Profit
This combination tells the story of a company that has no problem selling, but does so at poor margins or operates the company in such a way that it’s not retaining enough. There’s optimism for these companies. If they can continue to sell with great success, management can explore opportunities to increase margins or keep costs low to eventually generate better profits.
Low Revenue, High Profit
These companies are efficient because they’re able to generate strong profits off of fewer sales. This tends to be the case with big-ticket products or high-end services. Companies realize low sales potential, so they sell at higher margins to sustain the business. it’s a viable model, so long as these companies meet their break-even point with the few sales they do record.
High Revenue, High Profit
This is the best-case scenario and one every company strives for. High revenues mean the company has no trouble selling. High profit means all that selling is generating great margins and the company is operating lean enough to retain a majority of its income. The biggest challenge these companies face is tempering expectations in the event of a plateau.
Ultimately, profit is the most important figure. Companies with high profit have proven their ability to operate sustainably and generate shareholder value. Those without profit aren’t doing what it takes to stay afloat. Meanwhile, revenue figures tend to inform the success (or failure) of a company to maintain profitability. High revenue means plenty of sales; low revenue demands a ramp up in selling.
Measuring Revenue vs. Profit Over Time
Like most other raw financial figures, revenue and profit are best-observed over time, as trends. This paints a more accurate picture of a company’s operations. For example, a company might have a great quarter, with $100,000 in revenue and profits of $40,000 (40% margin). However, it could be an anomaly. If the company had $20,000 in revenue and $2,000 in profit in the previous quarter, investors would likely have questions!
Many industries also see inconsistent revenue and profit figures due to seasonal or cyclical sales. For example, travel and hospitality stocks tend to see revenue and profit spikes at certain times throughout the year (spring break, the holiday season) and lulls during other periods (new school year, early months). Observing revenue vs. profit over consecutive periods or against previous-year data provides more context.
Finally, it’s important to look at revenue and profit trends as they relate to each other. Ideally, a company will see growth in both. Rising sales and falling profit might signal management inefficiencies. Conversely, falling revenue and rising profit might suggest better margins or better management. In any case, investors should probe deeper to understand how one impacts the other.
The Most Important Metrics for Financial Health
Does a company have money coming in the door? How much of that money is it keeping? These two questions are the most important for evaluating the financial health of a business. Looking at revenue vs. profit tells a story of how it stays afloat, and they can also shed light on potential struggles.
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Independently, revenue and profit are good metrics for looking at the health of company operations. Revenue tells a lot about its sales and income, and the viability of customer-facing operations. Profit is a measure of efficiency and the business’ costing model, showcasing the ability to keep more money than it makes. Be sure to look at both when evaluating a potential investment, and keep in mind the context of the company’s growth stage as you do.